Differing Perspectives on Refinancing 1031 Properties

An essential concept behind the 1031 tax exchange process is that a real estate investor is not allowed to receive any cash benefit from the proceeds of the sale of his or her 1031 property; any sort of monetary benefit from the sale is seen as 'boot', and as a result it is subject to capital gains taxes. In accordance with this concept, the practice of refinancing for the purpose of removing stored value from your 1031 replacement property enters into a rather nebulous area with regard to acceptability under Section 1031.

In a court case brought against an investor by the name of Garcia, the court ruled that all benefit gained by a taxpayer resultant from the refinancing of a piece of real estate in advance of selling it in an exchange will be considered to be boot. This court decision set a standard for dealing with these kinds of situations . As of today, a more common strategy is waiting until after the closing on the replacement property, and to refinance at some point afterward. This tactic, however, brings up the issue of how long it is appropriate to wait before refinancing and taking equity from a property.

The old guard among real estate investors would likely tell you that you should wait a considerable period of time after closing (perhaps as long as two years after), in order ensure that you're in compliance with the intent of 1031. The current trend among more liberal minded school of property investors, however, is to say that closing on the purchase of a replacement property marks the definitive ending of to the 1031 process, and that an investor does not need to fret over the substantiation of an exchange from there onward. For a real estate investor who perceives the exchange process from this vantage point, it is irrelevant how long one waits before refinancing one's 1031 replacement property, and many do indeed elect to do this immediately after the closing .

If you are looking for any sort of clear-cut rule as to when it is safe to refinance a 1031 replacement property, you are destined to be disappointed, at least within the confines of this article. The two schools of thought that I have described above are merely opinions, and they are examples of the extreme edges on a wide spectrum. Investors vary greatly when it comes to the manner in which they approach these types of gray areas, and the best suggestion that I am able to {impart is simply to enlist the help of a good tax adviser or expert in formulating your final decision, and to work together with him to decide on the approach that will work best in light of your specific situation.

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