What are the consequences of a cashout refi on an investment prop

11 Replies

Here is the situation. I have an investment property worth about 150k and a loan for slightly less than 50k. The property is currently financed at 5.125% int rate. I am considering doing a refi to lower the rate and pull out some equity as well. My question is how does the cash out work for tax purposes if the property is considered investment for the following situations? 1) If the cash out is used to improve the property? 2) Use the cash to purchase another investment property? 3) Use the money for something else, like a vacation, car, or going to Las Vegas? 4) Down the road if I were to do a 1031 exchange to purchase a larger property would this event matter?

Eric

Originally posted by @Eric Cybulski :

Here is the situation. I have an investment property worth about 150k and a loan for slightly less than 50k. The property is currently financed at 5.125% int rate.  I am considering doing a refi to lower the rate and pull out some equity as well.  My question is how does the cash out work for tax purposes if the property is considered investment for the following situations?  1) If the cash out is used to improve the property?  2) Use the cash to purchase another investment property?  3) Use the money for something else, like a vacation, car, or going to Las Vegas?  4) Down the road if I were to do a 1031 exchange to purchase a larger property would this event matter?

Eric

 Whatever you takeout is not taxable. It’s not a taxable transaction. 1031 is also not affected. If you take out more money than you put it, your basis gets affected, and will impact your gain cal when you sell it. 

If you use the cash out amount for another investment property, the interest will probably be deductible. Needs to be structured properly.

@Eric Cybulski

It works out great for any of the reasons you mentioned. No significant tax consequences -it’s a loan. However my father taught me only to borrow to make money not go on vacation. Seemed to be good advice. Enjoy the cash flow. I like equity lines in this financial environment. 

Originally posted by @Eric Cybulski :

Here is the situation. I have an investment property worth about 150k and a loan for slightly less than 50k. The property is currently financed at 5.125% int rate.  I am considering doing a refi to lower the rate and pull out some equity as well.  My question is how does the cash out work for tax purposes if the property is considered investment for the following situations?  1) If the cash out is used to improve the property?  2) Use the cash to purchase another investment property?  3) Use the money for something else, like a vacation, car, or going to Las Vegas?  4) Down the road if I were to do a 1031 exchange to purchase a larger property would this event matter?

Eric

Refinancing a property doesn't count toward your capital gain. You get realized gain only when you sell your property. 

Although the new interest rate may be lower, your debt service could increase due to the large loan amount, so I recommend you to start figuring out how to invest your money, so you are not paying the additional debt service for nothing.

I agree with your father Carl.  I was looking for some extreme.  The big variable here is that I can reduce my int rate and gain access to capital vs the equity line only gives me capital.

Valid point on increasing the debt service amount.  Over the years we have paid in a lot more than the minimum.  The goal would be to calculate the amount of cash we could pull out that would leave the monthly payment slightly less than the current amount

Originally posted by @Ashish Acharya :
Originally posted by @Eric Cybulski:

Here is the situation. I have an investment property worth about 150k and a loan for slightly less than 50k. The property is currently financed at 5.125% int rate.  I am considering doing a refi to lower the rate and pull out some equity as well.  My question is how does the cash out work for tax purposes if the property is considered investment for the following situations?  1) If the cash out is used to improve the property?  2) Use the cash to purchase another investment property?  3) Use the money for something else, like a vacation, car, or going to Las Vegas?  4) Down the road if I were to do a 1031 exchange to purchase a larger property would this event matter?

Eric

 Whatever you takeout is not taxable. It’s not a taxable transaction. 1031 is also not affected. If you take out more money than you put it, your basis gets affected, and will impact your gain cal when you sell it. 

If you use the cash out amount for another investment property, the interest will probably be deductible. Needs to be structured properly.  

Hi Ashish,

I might not be reading this properly, but are you saying that there are certain scenarios in which a refi might affect your property's basis? Thanks!

@Eric Cybulski , the cash out will affect your net proceeds in the event of a sale.  The requirements in a 1031 to avoid all tax are to purchase at least as much as you sell and use all of the proceeds to do that. 

So if you do a 1031 after a refinance you'll need to purchase the same amount of replacement real estate. But you'll have less proceeds to do it with. So make sure you've got your lending situation in hand.

If you sell without a 1031 it is very possible that you could owe more cash than you have in equity.  The refi doesn't affect your basis and gain.  But if you access your equity in a refi it won't be there to pay a tax bill if needed.

Originally posted by @Dave Foster :

@Eric Cybulski, the cash out will affect your net proceeds in the event of a sale.  The requirements in a 1031 to avoid all tax are to purchase at least as much as you sell and use all of the proceeds to do that. 

So if you do a 1031 after a refinance you'll need to purchase the same amount of replacement real estate.  But you'll have less proceeds to do it with.  So make sure you've got your lending situation in hand.

If you sell without a 1031 it is very possible that you could owe more cash than you have in equity.  The refi doesn't affect your basis and gain.  But if you access your equity in a refi it won't be there to pay a tax bill if needed.

So in this example for a 1031 Exchange I would need to purchase a property greater than $151k and I should make sure that I have at least $30k to $37.5k (20% to 25%) equity in the original property so that it can be rolled into the next property without causing any lending issue correct?

@Eric Cybulski Righto - although you can always come up with cash of your own.  You don't have to exactly replace the debt if you have cash from the outside to either provide the full amount or to supplement the down payment.  It's just a nasty surprise if you're counting on the equity for the down payment and it isn't there.

Originally posted by @Dave Foster :

@Eric Cybulski Righto - although you can always come up with cash of your own.  You don't have to exactly replace the debt if you have cash from the outside to either provide the full amount or to supplement the down payment.  It's just a nasty surprise if you're counting on the equity for the down payment and it isn't there.

 Perfect, that makes total sense.

@Eric Cybulski

Refi using an equity lime it is usually cheaper  faster and a lower rate today and I think for a while iwoth this economy. I have both long term fixed and equity lines as a hedge.  Use the equity line like its your checking account strategy to produce extra savings on your cash accounts. Why get 1/2 % interest when you can get 2-5% return -Pm me for more details.