When To Refinance Your 1031 Property - A Contentious Issue Among Investors

2008-03-26 Word Count: 462 Category: Taxes

One of the key concepts behind the process of a 1031 exchange is that an investor cannot receive any cash benefit from the proceeds of the sale of a relinquished property; any money removed from the transaction is seen as boot, and as a result it is subject to capital gains taxes. In accordance with this logic, refinancing for the purpose of removing equity from your 1031 replacement property enters into a very gray area in terms of compliance with Section 1031.

In a court case brought against a property investor by the name of Garcia, the court made it clear that all benefit gained by a taxpayer as a result of the refinance of a piece of property in anticipation of selling it in a tax exchange will be considered to be taxable boot. This court decision set a standard for the manner in which these sorts of situations. Currently, a more common tactic is to wait until the replacement property has been closed on, and to refinance the piece of property at some point afterward. This tactic, however, brings up some questions about how long one ought to wait before refinance and taking equity from your replacement property.

The most conservative investors will likely tell you that you should wait a considerable period of time post-closing (perhaps even as long as two years after), in order ensure that you are complying with the intent of Section 1031. The popular mindset among the more liberal-minded contingency of real estate investors, however, is to say that closing on your replacement marks the definitive ending of to the 1031 procedure, and so an investor need not fret over the substantiation of the exchange from there onward. For an investor who looks at the process from this vantage point, it is not relevant the amount of time one waits to refinance a 1031 replacement property, and many investors do indeed elect to do so right after the closing has occurred.

If you're hoping for any kind of clear-cut maxim as to when it is safe to refinance your replacement property, you are destined to be disappointed, at least within the confines of this article. The perspectives discussed here are only the opinions of a few, and are examples of only a few of the viewpoints an investor may take. Investors vary a good deal when it comes to how they elect to look at these sorts of legally gray areas, and the most useful suggestion that I can {give you is just to look to good tax adviser or expert in making your final choice, and to work together with him or her to figure out the path that will work best in the context of your specific case.

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