Different Perspectives on Refinancing 1031 Properties
One of the most essential concepts behind the process of a 1031 tax exchange is that a real estate investor must not receive any direct benefit from the money gained as the result of the sale of a relinquished property; any money removed from the sale is seen as boot, and what this means is that it is, in fact, subject to capital gains taxes. In accordance with this concept, refinancing in order to remove equity from your 1031 property enters into a rather gray area with regard to acceptability under Section 1031.
In a case involving an investor named Garcia, the court asserted that any benefit received by an investor as a result of the refinancing of a property in anticipation of relinquishing it for an exchange will be considered to be boot. This decision set a standard for the manner in which these kinds of situations. Currently, a more common strategy is to wait until after the closing on the replacement property, and to refinance at some point later. This practice, however, brings up some questions regarding how long it is appropriate to wait before performing this refinance and taking equity from your replacement property.
The most conservative of investors will likely tell you not to remove equity until a considerable time post-closing (maybe even two years after), to make absolutely sure you’re in compliance with the implicit meaning of 1031. The current trend among more liberal minded contingency of property investors, however, is to say that the closing on a replacement property represents the definitive ending point of to the 1031 procedure, and that an investor does not need to fret over the substantiation of the exchange after this point. For a property investor who looks at the exchange process from this vantage point, it is irrelevant the amount of time one waits to refinance one’s 1031 replacement property, and many do indeed elect to do so immediately after the closing .
If you’re expecting any sort of hard and fast rule as to when you ought to refinance a replacement property, then you are destined to be disappointed, at least within the confines of this short article. The two perspectives described here are only the opinions of a few, and are examples of the extreme edges on a wide spectrum. Investors vary a good deal in how they choose to look at these sorts of legally gray areas, and the most useful advice I am able to impart is simply to consult with a good tax adviser or legal expert in making your ultimate choice, and to work together with him or her so that you can decide on the approach that will work best in the context of your specific situation.
