Cash-out refi, buy, sell then 1031?

Real Estate Investor, Flipper, PM, vacation rental, Wholesaler · Athens, GA · Member since 2013 · 260 posts · 210 votes

This is probably a very basic question, but I have no shame when it comes to learning here in BP: I'm about to do a cash out refi on one property (#1) I own free and clear in order to use that cash as a down payment for a new property (#2).

If I can eventually sell property #1, am I able to 1031 the cap gains into the loan on the new loan for property #2? It's almost like a 1031 but it's like putting the cart before the horse in the typical sell-buy scheme of things.

Thanks in advance for your patience with my basic questions.

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Bill ExeterBusiness Member

1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes

12y

@Steven Hamilton II is right on the money. The most challenging part of a Reverse 1031 Exchange is the financing. Lenders are not excited about the Qualified Intermediary holding title to the property during the Reverse 1031 Exchange.

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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
12y
Originally posted by @Jack Tucker:
This is probably a very basic question, but I have no shame when it comes to learning here in BP: I'm about to do a cash out refi on one property (#1) I own free and clear in order to use that cash as a down payment for a new property (#2).

If I can eventually sell property #1, am I able to 1031 the cap gains into the loan on the new loan for property #2? It's almost like a 1031 but it's like putting the cart before the horse in the typical sell-buy scheme of things.

Thanks in advance for your patience with my basic questions.

Jack,

No, you wouldn't be able to do that. It must be a true sale.

Remember loans have nothing to do with your basis or gains. If you refinance out more than your basis you will still have to pay tax when you sell for more than your adjusted basis after depreciation.
[email protected]224-381-2660
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
12y
@Bill Exeter
[email protected]224-381-2660
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Robert Nichols
Investor · Boston, MA · Member since 2011 · 5 posts · 5 votes
12y
Just to be clear, there won't be any capital gains on the cash you take out when you refi. If you use the cash to buy a second property, you will not be able to do a 1031 exchange. You will only be able to do it when you sell property #1 and buy another property. I hope this helps.
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David Jones
Fairhaven, MA · Member since 2014 · 15 posts · 24 votes
12y
You need to be careful with these things, the IRS is not kind when it comes to mistakes. I am not an expert in this. I have just recently started to look at these as it seems you are. I don't know if the property is your primary or not (see bullet #2)

I would say that if property 1 is your investment property and you end up selling it, if I were you I'd just look into buying a property #3 as an investment.
- Reverse Exchange: A situation where the replacement property is acquired prior to transferring the relinquished property. The IRS has offered a safe harbor for reverse exchanges, as outlined in Rev. Proc. 2000-37, effective September 15, 2000. These transactions are sometimes referred to as "parking arrangements" and may also be structured in ways which are outside the safe harbor.
- Proper Purpose - Both the relinquished property and replacement property must be held for productive use in a trade or business or for investment. Property acquired for immediate resale will not qualify. The taxpayer's personal residence will not qualify.
- Ref: 1031.org
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Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
A 1031 exchange with real estate essentially requires that you sell a relinquished property (or several) and acquire a replacement property (or several); all proceeds from the relinquished property must be used to acquire the replacement in order to defer all gains.

So the closest thing to what you wrote in the OP is a "reverse exchange" where the QI acquires and the QI holds title to the replacement property and then you dispose of the relinquished property. This is a more expensive thing due to the fact that the QI must hold title.

As with any 1031 exchange, there is a timetable that must be upheld in order for the exchange to qualify. You cannot just decide to do this "eventually"; you must adhere to the timetable.

This next website has tabs that show answers to most of the 1031 FAQs:

http://www.1031corp.com/
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y
Hi Jack,

No, unfortunately what you describe will not qualify for 1031 Exchange treatment. The sale of one property and the paydown/payoff of debt on another property is not considered a sale and purchase of real estate since you already own the target property and are merely paying down the debt.

You can structure a Reverse 1031 Exchange whereby you acquire your replacement property (property #2) first and then you would have 180 calendar days to complete the sale and close on the sale of your relinquished property (property #1). Reverse 1031 Exchanges, while more costly and complicated, can significantly reduce the amount of risk that you have in a 1031 Exchange transaction.
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Jack Tucker
OP
Real Estate Investor, Flipper, PM, vacation rental, Wholesaler · Athens, GA · Member since 2013 · 260 posts · 210 votes
12y
@Bill Exeter and in fact, all respondents have been helpful here.

I actually have 3 different investment (not primary residence) properties with strong cap gains that I have owned for 3+ years. I am looking to sell them.

Now, I have found a killer off-market distressed-seller apartment complex and I cannot wait to do a traditional "sell-then-buy" standard 1031 exchange. I'm not willing to lose this deal and I have financing lined up and the building under contract to close in about 40 days on Feb 28th.

Is it possible to set up a Reverse 1031 Exchange that would allow me to:

1. Buy the new apt complex using a loan,

2. Within 180 days, sell ANY ONE OR ALL of the 3 current existing properties,

3. Use the capital gains to pay down the (at that point) existing loan for the apartment complex ?

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Wayne Brooks
Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
12y
You need to show the exact numbers to a CPA. I don't know the rules on a Reverse 1031, but on a traditional, I believe All the cash equity from the sale property has to go into the buy property(s).

@Steven Hamilton II

can help
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y
Hi Jack,

Yes, it is possible. However, we have to review all of the numbers to insure that you meet the reinvestment requirements as required. And, in a Reverse 1031 Exchange, the Qualified Intermediary is required to acquire and hold ("park") title to either the replacement property (preferred method for the taxpayer) or the relinquished properties. Many lenders will not permit the Qualified Intermediary to hold/park title to the replacement property, so we would have to hold/park title to the relinquished property. This adds some hurdles to the transaction, but it can be done if we can over come the hurdles. I'll send you a PM.
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
12y
@Jack Tucker ,

@Bill Exeter is the go to guy for 1031 exchanges.

It all depends upon the numbers. It does sound like a good situation for a reverse exchange.
[email protected]224-381-2660
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Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
First, get the replacement under agreement with a due diligence period and contingent on seller participation in the 1031 exchange. You need some time to line up your buyers and the more time you can get the easier it could be to do the exchange.

During due diligence period, find buyers for your 3 properties. If you find them quickly enough, you could proceed with a traditional 1031 exchange rather than a reverse exchange. Again, buyers would have to be willing to participate in the 1031 exchange whether traditional or reverse. 1031 exchanges involving multiple relinquished or replacement properties are always more challenging from what I've been told by the QI and the 1031 specialist attorney I have used.

And if a traditional exchange, then QI does not take title so lender participation is easier. That is why I have suggested what I wrote in this post.
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Jack Tucker
OP
Real Estate Investor, Flipper, PM, vacation rental, Wholesaler · Athens, GA · Member since 2013 · 260 posts · 210 votes
12y
Great advice all around. @Steve Babiak @Bill Exeter @Steven Hamilton II @David Jones

Here's another option string... The contract states that we will close on Feb 28th. That means i have a little, maybe very little window to identify a buyer. I don't want to give away the farm, but I would be more comfortable doing a traditional "non-reverse" exchange.

Hence, I have a brief but legit opportunity to get very serious about my off-market portfolio as follows:

1. Consider "investor" pricing on the properties and post them on the BP Marketplace. A take-it-or-leave-it price, no frills price. The BP investor price posted would not be visible on the MLS historical records and paint me into a corner later.

2. List them on the MLS with an agent closer to a retail price to see if we get a legit bite from locals not on BP. This could be done simultaneously with #1.

3. If no takers by the time I close on the new apartment building, I've lost nothing by trying #1 and #2 above and proceed with the Reverse Exchange if the lender agrees.

Sounds reasonable? Any downside to this strategy? Thanks again..
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
12y
Originally posted by @Jack Tucker:
Great advice all around. @Steve Babiak @Bill Exeter @Steven Hamilton II @David Jones

Here's another option string... The contract states that we will close on Feb 28th. That means i have a little, maybe very little window to identify a buyer. I don't want to give away the farm, but I would be more comfortable doing a traditional "non-reverse" exchange.

Hence, I have a brief but legit opportunity to get very serious about my off-market portfolio as follows:

1. Consider "investor" pricing on the properties and post them on the BP Marketplace. A take-it-or-leave-it price, no frills price. The BP investor price posted would not be visible on the MLS historical records and paint me into a corner later.

2. List them on the MLS with an agent closer to a retail price to see if we get a legit bite from locals not on BP. This could be done simultaneously with #1.

3. If no takers by the time I close on the new apartment building, I've lost nothing by trying #1 and #2 above and proceed with the Reverse Exchange if the lender agrees.

Sounds reasonable? Any downside to this strategy? Thanks again..

Sounds reasonable; however, I would make sure that you begin talking to the lender about your interest in a reverse exchange.
[email protected]224-381-2660
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y
@Steven Hamilton II is right on the money. The most challenging part of a Reverse 1031 Exchange is the financing. Lenders are not excited about the Qualified Intermediary holding title to the property during the Reverse 1031 Exchange.
Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
Website View Page
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Shaun Reilly
Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
12y
Some of the talk here has made me curious about the rules around the proceeds of a 1031 exchange.

If you do a refi and then sell later with a 1031 is that a way to lower the "proceeds" that need to be rolled into the next place?

For example: You buy a place for $200K and have a $160K mortgage on it. After some time it appreciates to $270 and you pay the mortgage down to $150K. You do a cash out refi and put a new $216K mortgage on it and pocket $66K. Some time later (don't know if the time will matter) you sell the place for $270K and 1031 exchange it. The "Proceeds" of the sale would be the $54K (less selling expenses) above the $216K mortgage payoff. So that would go into the new place but would you be able defer the full $70K gain if you are putting less than that into the new place and you took out the equity ahead of the exchange?
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Jack Tucker
OP
Real Estate Investor, Flipper, PM, vacation rental, Wholesaler · Athens, GA · Member since 2013 · 260 posts · 210 votes
12y
Unfortunately, I don't think that the refi would help pull money out permanently, based on my phone conversation with @Bill Exeter

I'll let him comment.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y
@Shaun Reilly - yes, you can do a cash out refi as long as it is not too close to the sale and 1031 Exchange. It merely converts some of your equity into debt so that you have less equity (net proceeds) at the close of your sale. If you are too close to the sale/exchange, then I would not do the cash out refi on the sale, but would complete the 1031 Exchange and then wait a few months and then cash out refi on the back end. It is probably safer on the back end than on the front end.
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Shaun Reilly
Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
12y
Originally posted by @Bill Exeter:
@Shaun Reilly - yes, you can do a cash out refi as long as it is not too close to the sale and 1031 Exchange. It merely converts some of your equity into debt so that you have less equity (net proceeds) at the close of your sale. If you are too close to the sale/exchange, then I would not do the cash out refi on the sale, but would complete the 1031 Exchange and then wait a few months and then cash out refi on the back end. It is probably safer on the back end than on the front end.

Thank you for the information.

How close would be "to close" in your opinion?
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y
I generally recommend six (6) months or more - the longer the better - if refinancing before the 1031 Exchange, and two (2) or three (3) months if refinancing after the 1031 Exchange.
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Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
Originally posted by @Shaun Reilly:
...

If you do a refi and then sell later with a 1031 is that a way to lower the "proceeds" that need to be rolled into the next place?

For example: You buy a place for $200K and have a $160K mortgage on it. After some time it appreciates to $270 and you pay the mortgage down to $150K. You do a cash out refi and put a new $216K mortgage on it and pocket $66K. Some time later (don't know if the time will matter) you sell the place for $270K and 1031 exchange it. The "Proceeds" of the sale would be the $54K (less selling expenses) above the $216K mortgage payoff. So that would go into the new place but would you be able defer the full $70K gain if you are putting less than that into the new place and you took out the equity ahead of the exchange?

The cost basis must be rolled into the exchange AS WELL AS the gains being rolled in, in order to defer income tax on the gains. Anything else results in "boot" for which you do not income taxes.
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Shaun Reilly
Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
12y
Originally posted by @Steve Babiak:

Originally posted by @Shaun Reilly:
...
If you do a refi and then sell later with a 1031 is that a way to lower the "proceeds" that need to be rolled into the next place?

For example: You buy a place for $200K and have a $160K mortgage on it. After some time it appreciates to $270 and you pay the mortgage down to $150K. You do a cash out refi and put a new $216K mortgage on it and pocket $66K. Some time later (don't know if the time will matter) you sell the place for $270K and 1031 exchange it. The "Proceeds" of the sale would be the $54K (less selling expenses) above the $216K mortgage payoff. So that would go into the new place but would you be able defer the full $70K gain if you are putting less than that into the new place and you took out the equity ahead of the exchange?

The cost basis must be rolled into the exchange AS WELL AS the gains being rolled in, in order to defer income tax on the gains. Anything else results in "boot" for which you do not income taxes.

This is probably an issue of semantics but your basis would be what you paid for the place adjusted up or down based on capital improvements and depreciation. How could you ever roll your full basis into a new place if you had the original place financed, or had any other liens to be paid?
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Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
I don't believe depreciation is adjusted out - maybe somebody can offer input on that.

When you sell, your loans and liens get paid off at closing. You might have to get financing on the replacement property ...
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Shaun Reilly
Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
12y

I'm not an expert or have any experience at all with these so I'm only saying what I have heard and what my understanding is.

So my understanding is that when you do a 1031 you have to roll all the proceeds from the sale into the new place or be subject to taxable "boot".

Proceeds would be:

1) The taxable gain

2) The taxable depreciation recovered (Which I totally ignored in my example before)

3) Any other equity such as the original down payment and any mortgage pay down over time.

So mostly my original interest was if you could do a cash out refi to get out some of #3 with having to tie it up in the new place (and I guess if you could maybe get a little bit of #1 too if the LTV worked out).

Based on what @Bill Exeter had said I had the impression you are able to refi a place and it would not effect the transaction as long as you don't do it very close to when you sell.
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
12y
Originally posted by @Shaun Reilly:

I'm not an expert or have any experience at all with these so I'm only saying what I have heard and what my understanding is.

So my understanding is that when you do a 1031 you have to roll all the proceeds from the sale into the new place or be subject to taxable "boot".

Proceeds would be:

1) The taxable gain

2) The taxable depreciation recovered (Which I totally ignored in my example before)

3) Any other equity such as the original down payment and any mortgage pay down over time.

So mostly my original interest was if you could do a cash out refi to get out some of #3 with having to tie it up in the new place (and I guess if you could maybe get a little bit of #1 too if the LTV worked out).

Based on what @Bill Exeter had said I had the impression you are able to refi a place and it would not effect the transaction as long as you don't do it very close to when you sell.

You must roll over every dime to avoid taxation and any recapture.
[email protected]224-381-2660
1 Reply
Shaun Reilly
Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
12y
Originally posted by @Steven Hamilton II:

Originally posted by @Shaun Reilly:

I'm not an expert or have any experience at all with these so I'm only saying what I have heard and what my understanding is.

So my understanding is that when you do a 1031 you have to roll all the proceeds from the sale into the new place or be subject to taxable "boot".

Proceeds would be:

1) The taxable gain

2) The taxable depreciation recovered (Which I totally ignored in my example before)

3) Any other equity such as the original down payment and any mortgage pay down over time.

So mostly my original interest was if you could do a cash out refi to get out some of #3 with having to tie it up in the new place (and I guess if you could maybe get a little bit of #1 too if the LTV worked out).

Based on what @Bill Exeter had said I had the impression you are able to refi a place and it would not effect the transaction as long as you don't do it very close to when you sell.

You must roll over every dime to avoid taxation and any recapture.

The question was if you did a cash out refi prior to doing an exchange (and lets just keep it to equity above any taxable gain and depreciation recapture) to get some of the equity, how long before hand to not have it be an issue?

I'm sure if you do it a month before doing an exchange that will get an IRS eyebrow raised, but what about 6 months? What about a year? What about investors who's sole strategy is to buy a place for cash, fix it up and then do a cash out refi but then want to do a 1031 15 years down the road?
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