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How To Take Cash Out Of A 1031 Exchange

Dave Foster
5 min read
How To Take Cash Out Of A 1031 Exchange

Are you interested in deferring your taxes when you transition between investment properties but don’t want to roll all of your cash proceeds forward into your replacement property? Don’t be put off by the cash reinvestment requirement of a 1031 exchange. Cashing out is possible, but the “when” and “how” can make a huge difference. 

With some advanced planning, it may be possible for you to defer all the tax and access the cash you need. Read on to discover the vastly different requirements and consequences for accessing cash before, during, or after your 1031 exchange. 

1031 Exchange Reinvestment Requirements

A quick 1031 exchange refresher. To successfully defer all taxes with a 1031 exchange, you must:

  1. Purchase as much or more than your net sales price
  2. Use all of the proceeds in that transaction. 

It’s that second requirement to reinvest all cash proceeds that discourages some investors from exploring this portfolio-building opportunity further. 

But cashing out is possible. 

No matter your reason, understanding the rules surrounding cashing out can help you use a 1031 exchange to your benefit while accessing the cash you need.

The three options we will explore in this article are:

  • Cash-out refinance before you sell (can jeopardize your entire exchange if not done right)
  • Cash-out during the exchange (creates taxable “boot”)
  • Cash-out refinance after you sell (widely preferred by tax advisors)

Cash-Out Refinance Before Your Exchange

If you have refinanced your property recently for legitimate, documented business reasons and now have decided to sell using a 1031 exchange, those separate business decisions will be taken into consideration should you be subject to an IRS audit. For example, many investors refinanced during the pandemic to stay afloat but were able to successfully 1031 exchange out of their properties shortly thereafter. This unique and verifiable business emergency allowed them to both refinance and then exchange with full tax benefits.

However, refinancing your property just before your exchange to simply extract cash for personal or even unrelated business reasons is not recommended. This is because the IRS has a successful track record of linking this type of refinancing activity to the subsequent exchange as a taxable event by calling it a step transaction. 

With a 1031 exchange, you must follow all of the rules to avoid being taxed. If you know you are going to exchange and are simply skirting around the reinvestment rules by pulling money out just before the sale with a refinance, the IRS has consistently ruled this to be cash out of the exchange (for some reason, they call this “boot”). While most advisors are comfortable with refinancing activity for other than related business reasons a year or more before the exchange, a conservative approach is to allow two years between such a refinance and your exchange.

In court cases, the IRS has successfully argued that refinancing before an exchange is essentially a receipt of taxable boot in a staged step transaction. It’s called a substance-over-form argument. Because taking cash out during the exchange is taxable boot, they have routinely convinced the courts that taking the same cash out via refinancing prior to the exchange is just a step in your exchange (although completed beforehand), bridging the exchange.

Specifically, the IRS might claim that to evade the tax, you took cash out prior to your exchange. Then you used a 1031 exchange to receive the full tax deferral despite receiving untaxed cash. But the IRS may contend that bridging the start date does not interrupt the step transaction. This is where their substance-over-form argument may prevail, and the cash out becomes taxable boot under 1031 Exchange rules and may even jeopardize the entire exchange.

In the event of an audit, leveraging your property just before an exchange may raise this suspicion. A cash-out refinance is not recommended unless you can document convincing, mitigating factors that it is not boot. 

As a significant challenge in pre-exchange refinances is showing separation, planning ahead to put as much time as possible between refinancing and exchanging may be helpful if you must take this route.

The consensus among most experts is that refinancing your replacement property pre-exchange poses significant hurdles in the event that you are audited. 

Taking Cash Out During a 1031 Exchange

Although taking cash out during your exchange will be a taxable event, sometimes, this is the best available option, especially for personal rather than business use. This type of cash-out results in a partial exchange.

Ensure that your exchange agreement with your Qualified Intermediary allows you to access your cash proceeds at any of the following times:

  1. At the closing table of your sale
  2. The first business day after day 45, if you do not identify any replacement properties or have closed on all identified replacement properties
  3. At any time after day 45, if/when you finalize the purchase of all replacement properties and have funds left in your account
  4. The first business day after day 180

Any amount you receive will be counted as profit first by the IRS. Your personal tax accountant will be the best source of information on the estimated consequences of a partial exchange. 

Note that Section 1031 rules consider it taking boot when the exchanger receives cash at the closing table of the purchase. While reimbursement for out-of-pocket earnest money is possible without tax consequence, any other cash received at closing is considered boot. This includes borrowing more cash than is needed to acquire the replacement property.

Taking Cash Out After a 1031 Exchange

While there is no clear-cut rule or allowance for it, the IRS has largely acquiesced on replacement property refinanced post-exchange. However, as indicated above, it must be kept off the settlement statement of the purchase.

Here is what members of the Section of Taxation of the American Bar Association had to say on the matter: 

Post-exchange refinancings should be of less concern from a tax perspective than pre-exchange refinancings. Here, the integration of the refinancing with the acquisition of replacement property should not matter. Even where a new loan is obtained at the time or immediately following a taxpayer’s acquisition of replacement property in an exchange, receipt of cash by the taxpayer should not be treated as boot. 

There is, however, virtually no authority addressing this issue. The key to the distinction between pre- and post-exchange refinancings is that the taxpayer will remain responsible for repaying a post-exchange replacement property refinancing following completion of the exchange, whereas the taxpayer by definition will be relieved from the liability for a pre-exchange relinquished property refinancing upon transfer of the relinquished property. A fundamental reason why borrowing money does not create income is that the money has to be repaid and therefore does not constitute a net increase in wealth. This is clearly the case in a post-exchange refinancing and there is no analytic reason to characterize such financings as being in lieu of fictitious payments by the seller of replacement property.

To put this in context, if you refinance just before you sell using an exchange, it puts cash in your pocket, increasing your wealth as the debt for that cash is paid off at the time of sale. However, when you refinance after your purchase, the cash in your pocket is offset by a corresponding debt obligation, so there is no corresponding increase in wealth.

While not a failsafe, refinancing your new property is the most favorable method of accessing cash when completing a 1031 exchange. Even with this, you will want to:

  • Demonstrate that the refinance was for business reasons
  • Separate the refinance from other transactions, so there is no interdependence
  • Keep good documentation that it is an independent transaction
  • Avoid the appearance that it is a tax avoidance play

Completing a post-exchange refinance allows you to keep all your equity through a tax deferral and access it later on. 


In order of investor and expert preference, the options for taking cash out of your exchange are: 

  1. A post-exchange refinance (tax deferred)
  2. Cash-out during the exchange (best for personal use/taxable)
  3. A pre-exchange refinance (may jeopardize your exchange if not done correctly)

The whole point of a 1031 Exchange is to defer the tax when you transition from one investment property to another. While in the right circumstances, a cash-out refinance is possible prior to your exchange, most experts recommend taking cash out during the exchange for personal use and a refinance post-exchange for further investment use. 

If you are considering an exchange on an upcoming property sale but need cash out, start talking to your tax and legal advisors in advance to ensure you choose the best possible exchange structure. Acting well in advance gives your exchange the greatest opportunity to succeed.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.