financialfitnessblogs.com

1031 Exchange

We all know that the 1031 Exchange is used for transferring equity from an old property to a replacement property. In effect, the old debt is being offset by the new debt on the replacement property. However, there are two ways to usurp this premise and cash out some of your equity: pre-exchange refinancing, and post-exchange refinancing. To be tackled first is the pre-exchange financing.

To keep in line with the 1031 rationale, all of the proceeds from the sale are supposed to pass to the qualified intermediary – this prevents you from receiving any cash benefit from the sale. This prevents you from receiving any cash benefit from the sale; there may be times, however, when you would like to use some of your equity for your own entertainment or investments. So, you decide to refinance your property shortly before the 1031 exchange and use that equity for your desired luxury item. A good decision? Probably not, according to IRS v. Garcia.

In IRS vs. Garcia, it was decided that Garcia when refinancing his property in anticipation of the 1031 exchange, should have paid taxes on the money not used on the new property.Garcia tried to avoid the tax and ran afoul of the 1031 rationale and the IRS.In order for you to avoid the Garcia issue, you may decide to refinance the replacement property. The ‘boot’ is acceptable only if you pay taxes on it or cash out equity. Garcia tried to avoid the tax and ran afoul of the 1031 rationale, and the IRS.

If you don’t want to encounter the Garcia issue, you should decide to refinance the replacement property. This is a good way for you to take some of that equity out of the replacement property and buy more real estate. Not all taxpayers want to leave their equity in the replacement property – some want to take out that equity and buy more real estate. There is a question, however, on how long you have to wait before the refinancing after the 1031 Exchange is completed? Most people would wait a nanosecond.

Some will tell you that the time required for the finance is but a nanosecond. The nanosecond refinance is waiting just long enough after the 1031 Exchange to show the IRS through the closing statement that you have reinvested all of your equity into the replacement property. In a separate transaction, a new settlement statement is used to show that the replacement property was encumbered with new debt via a loan or mortgage, then there is a cash payment from the lender to you. Essentially, you have tapped into a pool of money made available through the tax exchange.

Whether the nanosecond exchange is legal is debatable. There are risks because there is no definitive IRS rule regarding how long you have to keep the equity in the replacement property. It can be done until two years have passed from the 1031 exchange to the ultimate refinance. In this case, keep the equity in the replacement property until the following tax year, or until two years have passed from the 1031 exchange to the ultimate refinance.