{"id":145496,"date":"2022-10-30T09:43:00","date_gmt":"2022-10-30T15:43:00","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=145496"},"modified":"2023-08-09T10:10:17","modified_gmt":"2023-08-09T16:10:17","slug":"how-to-take-cash-out-of-a-1031-exchange","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/how-to-take-cash-out-of-a-1031-exchange","title":{"rendered":"How To Take Cash Out Of A 1031 Exchange"},"content":{"rendered":"\n\n      <iframe loading=\"lazy\" frameborder=\"0\" height=\"200\" scrolling=\"no\" src=\"https:\/\/playlist.megaphone.fm?e=BIGPOC7705552563&#038;light=false\" width=\"100%\"><\/iframe>  \n\n\n\n\n<p><span data-preserver-spaces=\"true\">Are you interested in deferring your taxes when you transition between investment properties but don\u2019t want to roll all of your cash proceeds forward into your replacement property? Don\u2019t be put off by the cash reinvestment requirement of a 1031 exchange. Cashing out is possible, but the \u201cwhen\u201d and \u201chow\u201d can make a huge difference.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">1031 Exchange Reinvestment Requirements<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">A quick <a href=\"https:\/\/www.biggerpockets.com\/blog\/1031-exchange\" target=\"_blank\" rel=\"noreferrer noopener\">1031 exchange<\/a> refresher. To successfully defer all taxes with a 1031 exchange, you must:<\/span><\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Purchase as much or more than your net sales price<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Use all of the proceeds in that transaction.&nbsp;<\/span><\/li>\n<\/ol>\n\n\n\n<p><span data-preserver-spaces=\"true\">It\u2019s that second requirement to reinvest all cash proceeds that discourages some investors from exploring this portfolio-building opportunity further.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">But cashing out is possible.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">The three options we will explore in this article are:<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Cash-out refinance before you sell (can jeopardize your entire exchange if not done right)<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Cash-out during the exchange (creates taxable \u201cboot\u201d)<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Cash-out refinance after you sell (widely preferred by tax advisors)<\/span><\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Cash-Out Refinance Before Your Exchange<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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 \u201cboot\u201d). 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.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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\u2019s 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.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">The consensus among most experts is that refinancing your replacement property pre-exchange poses significant hurdles in the event that you are audited.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Taking Cash Out During a 1031 Exchange<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">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 <a href=\"https:\/\/www.biggerpockets.com\/blog\/partial-1031-exchange\" target=\"_blank\" rel=\"noreferrer noopener\">partial exchange<\/a>.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Ensure that your exchange agreement with your Qualified Intermediary allows you to access your cash proceeds at any of the following times:<\/span><\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">At the closing table of your sale<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">The first business day after day 45, if you do not identify any replacement properties or have closed on all identified replacement properties<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">At any time after day 45, if\/when you finalize the purchase of all replacement properties and have funds left in your account<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">The first business day after day 180<\/span><\/li>\n<\/ol>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Taking Cash Out After a 1031 Exchange<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Here is what&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/static1.squarespace.com\/static\/53e280c4e4b066b2bdba2095\/t\/5660b67fe4b0fa3340498fd6\/1449178751625\/Open+issues+in+like-kind+exchanges.pdf\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">members of the Section of Taxation of the American Bar Association<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;had to say on the matter:&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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&#8217;s acquisition of replacement property in an exchange, receipt of cash by the taxpayer should not be treated as boot.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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:<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Demonstrate that the refinance was for business reasons<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Separate the refinance from other transactions, so there is no interdependence<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Keep good documentation that it is an independent transaction<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Avoid the appearance that it is a tax avoidance play<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">Completing a post-exchange refinance allows you to keep all your equity through a tax deferral and access it later on.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Conclusion<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">In order of investor and expert preference, the options for taking cash out of your exchange are:&nbsp;<\/span><\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">A post-exchange refinance (tax deferred)<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Cash-out during the exchange (best for personal use\/taxable)<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">A pre-exchange refinance (may jeopardize your exchange if not done correctly)<\/span><\/li>\n<\/ol>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">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.<\/span><\/p>\n\n\n\n<div id=\"hero-block_62ee867235a1c\" class=\"first:mt-0 hero-block py-4    has-background has-slate-300-background-color has-text-color has-slate-800-color\">\n    <div\n        class=\"gap-10 lg:gap-20 flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 lg:w-2\/3 \">\n            <main class=\"py-4\">\n                \n\n<p class=\"has-theme-slate-color has-text-color has-large-font-size\" style=\"font-style:normal;font-weight:800\">Dreading tax season?<\/p>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-theme-slate-color has-text-color\" style=\"font-size:16px\">Not sure how to maximize deductions for your real estate business? In <em>The Book on Tax Strategies for the Savvy Real Estate Investor<\/em>, CPAs Amanda Han and Matthew MacFarland share the practical information you need to not only do your taxes this year\u2014but to also prepare an ongoing strategy that will make your next tax season that much easier.<\/p>\n\n\n\n<div id=button-custom-event-block_641384b1eb1d8 class='button-custom-event'>\n      <a href=\"https:\/\/store.biggerpockets.com\/products\/tax-strategies-book-bundle?utm_source=blog&#038;utm_medium=blog%20banner\" x-on:click=\"window.analytics.track(&#039;Blog Block | Publishing: Taxes Bundle&#039;, {\n      referrer: &#039;https:\/\/www.biggerpockets.com\/blog\/how-to-take-cash-out-of-a-1031-exchange&#039;,\n    });\" class=\" btn-shape inline-block no-underline has-background has-theme-gold-background-color has-text-color has-white-color\" target=\"_blank\">Get Yours Now<\/a>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n                <div class=\"lg:w-1\/3 first:mt-0 relative h-full lg:flex lg:items-center\">\n            <img decoding=\"async\" class=\"object-cover w-full relative z-20 my-0  rounded-md hidden lg:block\" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2023\/04\/tax-strategies-books.png\" alt=\"\" title=\"\">\n        <\/div>\n            <\/div>\n<\/div>","protected":false},"excerpt":{"rendered":"<p>Are you interested in deferring your taxes when you transition between investment properties but don\u2019t want to roll all of your cash proceeds forward into your replacement property? Don\u2019t be [&hellip;]<\/p>\n","protected":false},"author":3019,"featured_media":145264,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[7359,7119],"tags":[],"class_list":["post-145496","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-1031-exchanges","category-biggerpockets-daily"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/145496","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/3019"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=145496"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/145496\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/145264"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=145496"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=145496"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=145496"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}