Are we able to use the proceeds from a cash-out refi on an investment property and 1031 it towards another?
Also, if so, how does one go about putting that money into a 1031 exchange and doing this? I've never done this, so any and all information would be much appreciated, thank you!
@Lawrence Rutkowski , A 1031 is a sale of real estate followed by a purchase of real estate.
If you want to cash out refi property A and use the proceeds to buy and hold property B and then after a time sell property B and do a 1031 - yes you can do that. You'll need to make sure that you purchased property B to hold for productive use and not just to flip. a primary intent of immediate resale does not qualify for 1031.
If you want to refi Property A and use the proceeds to purchase something else and then sell property A and 1031 you probably cannot use a 1031. The IRS has consistently interpreted a cash out refi immediately before a sale as a way of accessing profit and denied the exchange. You would have a defense that you could show you were using your normal business model and not accessing funds for personal use but it's an iffy defense given the bulk of case law out there.
However if you wanted to sell Property A, 1031 and buy property B and then immediately refi property B and buy property C then that 1031 would qualify.
@Dave Foster Thanks for the response. Property B is going to be a buy and hold so there shouldn't be a problem there then.
Someone did tell me that a refinance is already tax free, but I am skeptical. Is that true?
@Lawrence Rutkowski yes a refinance is typically seen as borrowing against equity. Borrowing is not profit. So although you're getting cash it's not taxable.
The difference when you refi right before a 1031 is that the refi to get cash will not be accompanied by any length of debt service so the IRS views it as really just taking profit early.
That's why the recommendation is complete your 1031 and then immediately refi. You get the cash, it's not taxable, and your tenants are paying the P and I back.
Hi @Lawrence Rutkowski ,
Yes, you can do a cash-out refinance on property. The cash-out refinance is not taxable. You are merely taking debt out against the property, which you must pay back. You can use the cash-out refinance proceeds to invest in other rental property, and when you sell that rental property in the future you can structure a 1031 Exchange at that time.
The 1031 Exchange must be set-up prior to closing on the sale.
You should not refinance a rental or investment property and pull cash out just prior to selling and structuring a 1031 Exchange transaction. You want to make sure that it is clear that you had the intent to reinvest all of the proceeds into replacement property and not pull it out tax-free. You can certainly complete your 1031 Exchange and then after a few months do a cash-out refinance at that point.
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