Complicated topic, have you talked to a 1031 exchange agent?
It is my understanding that the current loans on a property are irrelevant to the 1031. The rehab loan would be like a 2nd mortgage. It would get paid off by the title company with sale proceeds. To avoid taxable boot, you just have to buy a more expensive property within the specified time parameters.
This would be no different than doing a 75% cash-out-refi today and putting the money in the bank, using some of it to rehab the property or go on vacation, anything you want. That is not a taxable event. No booty. The 1031 exchange doesn't care that you just did that.
@Burke Ericson , I responded back to you on some of this scenario. But for the good of the group - the specific question here is on how to handle repairs to get the property ready to sell. If you take a loan against the property to fix up prior to sale then it would be paid off with the sale. Your responsibility in a 1031 exchange in order to completely defer all tax is to purchase at least as much as you sell and to use all of the cash proceeds in the next purchase. While you don't technically have to take out identical debt most folks don't have their own cash to put in so they end up needing to match debt.
If you were willing to take the debt as boot then you would be left with just cash to make a cash purchase. And that might be a much better scenario for your mom. If her first mortgage as $150K and there was $50K that you borrowed to improve the property prior to sale then your responsibility to defer all tax would be to purchase about 1.2 mil in real estate and use all 1 mil in proceeds to do so. If you only wanted to purchase 1 million in real estate to avoid going into debt you can do that and pay tax on the $200K difference. So the improvements get washed in the sale.
The one caution to this scenario is that typically the IRS is skittish about refinances prior to a property being sold. I appreciate @?Gregg Scott's perspective of how debt does not affect gain. But there is a huge difference between a refi that happens right before the sale of a property and the commencement of a 1031 and a completion of a 1031 followed by a refi. They hate to see cash out refis because it is very easy to use that as an opportunity to inappropriately access gain prior to a sale. And when coupled with a 1031 it is not inconceivable at all that the IRS call that refi ahead of an exchange "boot" and declare it taxable.
In your case you can create a crystal clear paper trail of the purpose of the funds and the use of the funds and the receivers of the funds. You'll want to work with your accountant on this to make sure the use is crystal clear.
The other option is to access the funds from somewhere else and then fix up the property. This is a little cleaner than a refi right before a sale. But it would also require you to take boot to pay that back anyway.
She really should be able to do this without paying any tax.
There are several things to think about in this strategy and several ways to go based on a few unknowns not listed in your post.
If you replace the same debt % ....no mortgage boot
The fix up question really depends on how much you need to spend to ready it for sale and how long that might take. If it will sell quickly with just a buff/clean up as is might be the better way to go.