I am looking at selling a property, and 1031ing into a new property.

The seller is willing to carry a second mortgage.

I plan to close the purchase transaction using the cash from the 1031.

After that transaction closes, what happens if I then sign a second with the seller, and he gives the cash right back to me?

Would that cash be taxable? Or did I just take on additional tax deductible debt, and end up with the non-taxable proceeds from my original property?

Here is a good article by that relates to this subject.

http://www.biggerpockets.com/renewsblog/2014/08/21/strategy-take-cash-1031-exchange-tax-free/

 In most circumstances, an attorney or CPA will recommend refinancing the replacement property after completing the exchange transaction. Any refinancing should be done later and off the replacement property closing statement.

For your situation, I would get the opinion of your CPA, because this is a little bit different than a regular refi and not sure what would happen in case of an audit.

@Jamie Beckland

The best way to take cash out of a 1031 exchange is to complete your exchange and then take out new financing on the replacement property.  By doing it this way you show a complete custody chain for your funds to maintain the 1031. And at the end of the day you received non-taxable cash in the form of additional debt.

Your source of financing whether it is a bank, traditional refi lender or the former owner would be irrelevant.

Perfect! Thanks @Ryan Thomas and @Dave Foster. This confirms exactly what I thought. The important part is to create the second mortgage as a separate transaction, after the original deal closes. Thank you.