One of my clients in Arizona is considering do a Cash Out Refinance on a 4-Plex (Investment Property). The client plans to use the funds from the cash out refinance to pay off his personal residence.
Will this scenario create any tax issues for my client?
I was concerned that he would be converting funds from his investment property to personal and it could trigger a tax event on the converted funds.
Thanks for any thoughts any of you have!!!
Whatever you described is not taxable. Incurring a debt is not a taxable transaction no matter how the proceeds are used.
If the debt proceeds are used for business/investment purposes, interest is deductible.
No, the proceeds will not be taxable. But yes, it will create tax issues or, rather, tax consequences.
1. Say he had an existing $500k loan and refinances it into a $600k loan. The interest on the $100k will not be deductible, because it's used for personal. He will be able to deduct 5/6 of the total interest on the new loan.
2. Assume he sells the property for $750k and pays off the $600k loan. He may only receive $150k cash at closing (minus, of course, closing costs etc.) - but his taxable capital gain will be the difference between $750k and whatever he paid for the property originally ("tax basis"). He may end up having capital gain higher than cash proceeds from the sale. In essence, he will be taxed on the cash-out money when he sells the property.
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