Cash out refinance then later possible 1031 exchange

4 Replies

I bought a SFR a couple of years ago for $140,000 with a mortgage, and after fixing up the house, moving out and converting it to a rental, I now have about about $200,000 in equity. Can I take a cash out refinance now (taking about $50,000 out now) then in a year or two do a 1031 exchange to a new property without the 50K being considered boot?

@James Findley , Yes that's fine.  If you take out the refi well in advance of the sale and start of the 1031.  There's no statutory time frame.  But when a refi happens right before a sale and 1031 the IRS has had a tendency to view that as a way of taking profit and subsequently disallowed the exchange if it was audited.  A year or two in advance is generally fine.  And if you want to be more conservative wait until after the 1031 and refi the replacement property after the 1031 is complete.

Originally posted by @James Findley :
I bought a SFR a couple of years ago for $140,000 with a mortgage, and after fixing up the house, moving out and converting it to a rental, I now have about about $200,000 in equity. Can I take a cash out refinance now (taking about $50,000 out now) then in a year or two do a 1031 exchange to a new property without the 50K being considered boot?

Short answer - yes. The boot becomes an issue when the IRS considers the money to be received in the process of doing an exchange. When something is done immediately before an exchange, the IRS could argue that the two transactions should be considered as one - i.e. merely a two-step process. 

When you don't have any specific plans for an exchange, just some vague "maybe in a year or two" intention - the IRS can't make such argument. If they do, I will gladly take the case to defeat them.

One caveat though: in a 1031 exchange you need to get the same amount of debt or higher. If you exchange now, the minimum required debt on the replacement property is $150k. If you do an exchange after the refi - then you will have to get at least $200k debt.

Also - kudos for thinking ahead and asking good questions in advance.

@James Findley And who better to be in your corner with the IRS than the Black Belt in Taxation himself!!

One caveat on your caveat though @Michael Plaks - Equal or greater debt is not strictly required.  James could come in with funds from any other source to replace a mortgage in a 1031 purchase.  What is required to defer all tax is that he purchase at least as much as his net sale and that he use all of his proceeds in the purchase.  

What you and I see so often is that there is no other sources of cash so they have to take out equivalent debt in order to make the purchase target.  But it's not a requirement. 

Originally posted by @Dave Foster :

@James Findley And who better to be in your corner with the IRS than the Black Belt in Taxation himself!!

One caveat on your caveat though @Michael Plaks - Equal or greater debt is not strictly required.  James could come in with funds from any other source to replace a mortgage in a 1031 purchase.  What is required to defer all tax is that he purchase at least as much as his net sale and that he use all of his proceeds in the purchase.  

What you and I see so often is that there is no other sources of cash so they have to take out equivalent debt in order to make the purchase target.  But it's not a requirement. 

Correct. And I have only seen one exchange where a client of mine brought cash to the table.