How to pay yourself if you elect a 1031 exchange

Question

Hi there,

Very new and ignorant to real estate but was somewhat dragged in without being prepared. Here's the situation.... I have a home that is currently being rehabbed and that I plan to sell next year sometime. I hope to avoid capital gains by using a 1031 exchange but then am not sure how I would pay myself and my partner?? Is this possible? Or do I need to pay the capital gains if I want money in money pocket after the sale. Any tips or suggestions are greatly appreciated. Thanks!!

Bill Exeter · Answer

Hi @Roman Capone,

Properties acquired with the intent to rehab/fix and then sell or "flip" do not qualify for 1031 Exchange treatment since the property is technically held for sale and not held for rental, investment or business use.  You would sell, pay ordinary income tax rates since it was held as a rehab/flip property, and then you would have access to all of your net proceeds.

You could buy, rehab/fix and then hold as rental property (if that conforms to your business plan) and then once you sell you would qualify for 1031 Exchange treatment because you held the property for rental purposes and not for sale.  However, with a 1031 Exchange, there is no way to pull cash out to "pay yourself" since you must reinvest everything in order to defer the taxable gain and paying the corresponding taxes.

It is all about your intent to hold for investment vs. hold for sale.  You can certainly 1031 Exchange into other replacement property and then after a few months apply for a cash out refinance loan.

Dave Foster · Answer

@Roman Capone, any money you take out of a 1031 exchange is going to be considered profit and will be taxable.  If you want full tax deferral and cash out you must finish up the 1031 and then do a refinance after the fact.  This way you are not seen as taking profit out.  You are borrowing against equity.

However, be careful.  If you are simply buying a property to rehab and sell you cannot do a 1031 exchange because you did not buy it with the intent to hold.  You bought it with the primary intent of reselling.  Even if it goes into next year your intent still must have been to hold for productive use.  Holding a property for over a year or over two tax years can reinforce your stated intent.  But the intent must be there.

How to pay yourself if you elect a 1031 exchange

Most Popular Reply