Deferring Taxes for Real Estate Portfolio

Member since 2024 · 9 posts · 4 votes

Hello Everyone,

I know the 1031 exchange is used to defer the capital gains under the condition you use it to buy another home. Is there a tax strategy for using capital gains off the sale of a home to pay off other homes in your portfolio to improve cashflow? Thoughts?

California !

Best,

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Andrew Abeyta

Accountant · Member since 2024 · 26 posts · 5 votes

Unfortunately not, Gabriel. 1031s are quite strict, and involve equal “equity” deployed in order to persevere the gain deferral.

That said, if you’re okay with realizing *some* capital gain on boot / mortgage boot, you can pull *some* cash from the 1031 exchange. You would need an exceptional grasp on what the 1031 will cost and the amounts you’re dealing with on the replacement and relinquished properties.

- REI CPA in CA

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Andrew Abeyta
Accountant · Member since 2024 · 26 posts · 5 votes
2y
Unfortunately not, Gabriel. 1031s are quite strict, and involve equal “equity” deployed in order to persevere the gain deferral.
That said, if you’re okay with realizing *some* capital gain on boot / mortgage boot, you can pull *some* cash from the 1031 exchange. You would need an exceptional grasp on what the 1031 will cost and the amounts you’re dealing with on the replacement and relinquished properties.
- REI CPA in CA
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Sean RossPro Member
1031 Exchange Qualified Intermediary · Denver, CO · Member since 2017 · 176 posts · 97 votes
2y
Quote from @Gabriel Zepeda:

Hello Everyone,

I know the 1031 exchange is used to defer the capital gains under the condition you use it to buy another home. Is there a tax strategy for using capital gains off the sale of a home to pay off other homes in your portfolio to improve cashflow? Thoughts?
California !

Best,

GZ

Hello @Gabriel Zepeda,

As @Andrew Abeyta correctly mentioned, there is not a direct and clean way to use 1031 exchanges to pay off debt on your existing portfolio. 1031s are great for lots of things, and they're really important to serious investors; however, they are not very useful as a tool for deleveraging.

Rather than taking out some boot from your sale to pay off debt, you could take a detailed look at your financing math after buying a new property and then strategically refinance to replace expensive debt with cheaper debt, but this is not very easy in today's rate environment.

If you do decide to have a "partial" 1031 exchange and use some of your 1031 sale proceeds to pay off debt on other assets, you'll just want to make sure that the improvement in cash flow offsets the tax liability that you incur from your partial exchange AND the lower rents from potentially buying a less valuable property with your partial 1031 exchange.
Otherwise, you're looking at trying to buy the best cash-flowing property with your 1031 exchange so that you can use the monthly income stream to pay off your total debt a little bit faster.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
2y
@Gabriel Zepeda, There are a number of ways to "sort of" do this. None perfect. Because as you said, the 1031 at its heart is used to sell and then buy new investment real estate. But here's some tactics to explore and compare.

1. The partial exchange already addressed. You'll pay tax only on what you pull out of the 1031 exchange. And it may be worth it if paying off the other loan frees up significant cash flow in reduced mortgage payment.

2. A cash out refinance post - 1031. It's perfectly fine to purchase your new property using a complete 1031 echange. And then after the fact do a cash out refinance to pay off the other mortgage. It may seem like trading debt for debt. But there could be reasons like type and terms of financing that make this an attractive option

3. A cash out refinance with a full 1031 on steroids!!. With this model you use your 1031 exchange to purchase two replacement properties. One for cash and one with the maximum leverage. By doing this you've completed a full 1031 exchange so you don't own any tax. You've also concentrated your equity so you can do a cash out refinance on that property without affecting the other loan at all. And best of all, you don't have to do that cash out refi immediately. As long as that property sits the equity doesn't cost you anything. But any time you want you can tap it to pay off a loan or buy another property.
Or.... check this out - sell two properties and 1031 both of them into two more properties. But since you can allocate your proceeds any way you want, you combine the exchanges and buy two replacement properties - one with cash and one with debt. This has the same effect as doing a partial exchange and paying off one property. But in this scenario, you also don't have to pay tax on the boot that you took out of the exchange to pay off the note.
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