Boot on a 1031 Exchange

Member since 2020 · 10 posts · 1 vote

You have a property worth $800k. Mortgage is $300k. You sell the property and have $500k profit proceeds (for simplicity, no costs).

For a 1031 can you buy two replacement rental properties; One for $400k paid in full, zero mortgage. Then a second for $400k or more with 100k down and at least a $300k mortgage?

After the close of the 1031 in the above scenaio, could you then cash out refinance the fully paid property and make use of the cash? You would have lower fees and costs than trying this with the two properties.

The thinking is this. Getting cash flow from both properties after a 65% or so loan may work but you are realy left with no cash. To get cash after closing you would incur costs and fees on the two loans.

Or you would have great cash flow from one property and hopefully debt coverage on the other.

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Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

3mo

@Frank Harrington yes! As long as you meet your reinvestment requirements of the 1031 exchange, you can allocate the proceeds any way you like. We call this a diversification exchange. Investors who want to diversify into better markets and mitigate risk by purchasing one property with cash and the second with debt will utilize this strategy.

There's nothing wrong with doing a cash-out refi immediately after your 1031. This is actually a tax-free way to access some cash since you must leave all of your proceeds in your exchange to satisfy your reinvestment goals. Some investors will even use it as a down payment on another property. Great thinking!

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Pierre Guirguis
Lender · Marlboro, NJ · Member since 2025 · 243 posts · 148 votes
3mo
Two replacements at $800k total with the full $500k reinvested keeps the exchange clean, and since you're taking on $300k of new debt against the $300k you're paying off, you avoid mortgage boot too.

On the part you're really asking about: a cash-out refi after the exchange isn't boot and isn't taxable, since you're borrowing against equity, not taking exchange proceeds. What matters is that it's a genuine separate transaction, not something baked into the exchange itself. Close the 1031, then refinance the paid-off property on its own. People get burned when the refi looks pre-arranged as part of the swap, not because of any specific waiting period.

Your economics are right too, one cash-out on the free-and-clear property beats financing both, and you keep one as strong cash flow while the other carries its own debt.
That paid-off property is the one to pull from, I'm on the financing side, so once you know which it'll be, happy to run exactly what the cash-out looks like
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
3mo
@Frank Harrington yes! As long as you meet your reinvestment requirements of the 1031 exchange, you can allocate the proceeds any way you like. We call this a diversification exchange. Investors who want to diversify into better markets and mitigate risk by purchasing one property with cash and the second with debt will utilize this strategy.

There's nothing wrong with doing a cash-out refi immediately after your 1031. This is actually a tax-free way to access some cash since you must leave all of your proceeds in your exchange to satisfy your reinvestment goals. Some investors will even use it as a down payment on another property. Great thinking!
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Jason MalabuteBusiness Member
Accountant · Los Angeles, CA · Member since 2016 · 2k+ posts · 900 votes
3mo
Yes, you can do basically what you're describing. As long as you hit your reinvestment targets on the exchange, you're free to spread the proceeds across more than one replacement property, so buying one free-and-clear and putting debt on the other is fine. The cash-out refinance afterward isn't boot and isn't taxable either, because you're borrowing against your own equity rather than pulling money out of the exchange itself. The one thing to be careful about is keeping that refinance as its own separate transaction once the 1031 has closed, since it can draw scrutiny if it looks like it was arranged as part of the exchange from the start. As always, the right move depends on your specific numbers, so confirm the details with your own CPA or qualified intermediary.
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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
3mo
Hey Frank,

Pierre and Jason covered the mechanics of it well, so I'll just add some reasoning. The IRS looks at the exchange as a whole, not each replacement property individually. As long as you reinvest all of your net proceeds and replace the total value and debt of the property you sold, you're generally fine. So buying one property with cash and financing the other can work if the overall numbers line up.

On the cash-out refinance, timing and intent matter. There's no set waiting period, but, like Jason said, you want the refinance to be a separate transaction after the exchange closes, and not part of the 1031. If it looks pre-arranged, the IRS could treat it as taxable boot.
BP is great because there are knowledgeable CPAs and qualified intermediaries on here who regularly contribute, and it could be worth finding one who specializes in 1031 exchanges if you plan to do more of them.

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Rob Bergeron
Real Estate Agent · Louisville, KY · Member since 2017 · 1k+ posts · 1k+ votes
1mo
@Frank Harrington your structure question is one for your QI and CPA - I'm a realtor, not either of those, and the boot math on a split like this gets specific fast.
But the part nobody has answered yet is where two $400k properties actually go, so let me take that one.
I'm in Louisville. As of this morning there are 329 active single-family listings in Jefferson County between $350k and $450k. That's not a thin shelf you have to fight over - it's a real selection inside a 45-day identification window, which matters more than people appreciate. The identification clock kills more exchanges than the price does.
What I'd flag about doing it here specifically: our price per square foot varies close to 3x across the county, so the median tells you almost nothing. A $400k house in the Highlands and a $400k house in the East End are different investments with different tenant pools and different exit liquidity. Compare inside the submarket or you'll get the wrong answer confidently.
One more thing worth knowing before you commit to the leveraged one. Our inventory is up about 30% year over year and pending sales are down 19%, but sellers are still averaging 98.4% of list. Prices haven't broken here. Leverage has. Which means the concession you can actually get right now is terms - rate buydown, credits, seller carry - not price. If you're structuring one of these leveraged, that's where your negotiating room is.
Happy to be a sanity check on any market you're weighing, including ones I don't work in.
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Dan HandfordPro Member
Investor · Lexington, SC · Member since 2018 · 779 posts · 501 votes
1mo
The allocation makes sense conceptually, provided the exchange and replacement properties satisfy the applicable requirements. I would separate the tax question from the financing question. Even if the structure works for the exchange, the later refinance still needs to make sense under realistic valuation, seasoning, lender, and debt-service assumptions. I would also preserve enough liquidity that the plan does not depend on receiving every anticipated refinance dollar. After the refinance, how much cash reserve would you want to retain across both properties?
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