I am looking into selling a single property and using the proceeds in a 1031 exchange to purchase 2+ properties. My question for those that have done this or are familiar is what is the better strategy....1) Identify and purchase multiple properties in the 1031 exchange or 2) Purchase the first property in the 1031 and then after the needed seasoning period, do a cash out refinance and then purchase the second property.
I am not sure if one strategy is easier or more cost efficient than the other? Obviously, if multiple properties can not be identified in the 45 day time period that makes the decision for me.
Any insight from the experts would be appreciated. Thanks!
I would think that the fees required to set up the 1031 would be offset better by purchasing two or more at the same time. However, you'd have to talk to the exchange company about that...
@Chris T. , This doesn't have to be an either/or I don't think.
1.Most intermediaries only add a small charge for a second purchase so you can do a quick comparison of 250 - 500 for a second purchase in the 1031 vs the costs of the refi loan.
2. As long as the first property you buy can potentially absorb the entirety of your exchange reinvestment target there's no reason to make an immediate decision. If another property crops up in the 45 day period then identify negotiate and buy as part of the exchange. If not then use all your proceeds for the first purchase and move to the refi plan.
3. There is no "seasoning period' after completion of your first purchase for you to refinance to buy something else. So you can immediately access the equity in the replacement property to purchase another property if you choose.
@Dave Foster in the refi scenario can you do a cash-out and use the funds for something other than real estate without triggering a tax event?
@David Shapiro , It's not a taxable event because you are simply borrowing money secured by your property. Depending on the use of the refi the interest may or may not be deductible.
Let me make sure I'm understanding this correctly. Let's say you have a $250k house you're selling with a $100k loan and $125k Basis. After selling you have a gain of $125k and net proceeds of $150k. You 1031 exchange into a $300k house.
Scenario 1: You put down $75k, get a loan for $225k. You retain $75k of the proceeds in cash. How much of your gain is deferred?
Scenario 2: You put down all of the cash you receive from the sale, $150k, and get a loan for $150k. 100% of capital gains tax is deferred, right?
Then the following week you do a cash-out refi and get a $225k loan. That gives you $75k in cash. This is not a taxable event, correct?
If my understanding of your above comment is correct these two scenarios have essentially the same outcome but with much different tax consequences.
@David Shapiro , That's exactly correct!!! In order to defer all tax in a 1031 exchange you must purchase at least as much as you sell and you must use all of the proceeds in the purchase. If you take cash out (like scenario 1) the IRS sees that as taking profit so that $75K would be taxable.
However, if you follow scenario 2 then the refinance is not taxable. And yes you can use the proceeds for anything you want not just real estate (although there may be some impact on your ability to deduct the interest depending on what you buy).
Is this a great country or what!!!
BTW - For @Chris T. also I don't know if I came through clearly enough on another aspect. If you purchase one property as a replacement and then refi you won't get access to your full equity. So you will end up with more equity in each replacement property. If you use the proceeds from the first 1031 to purchase multiple properties you'll have the use of 100% of the equity from that sale. That may or may not be enough to make a huge difference to you.