Yes, that can be a work around. The key thing for inveestors to keep in mind is the INTENT to HOLD for investment by REINVESTING the entire value of the relinquished property.
The question is when can you refinance and pull cash out without triggering any risk as to capital gains?
There is a Private Letter Ruling issued by the IRS where the gentleman had refinanced the week after closing on his replacement property and the IRS did not disallow the transaction. This is not a slam dunk however. The PLR was requested for another issue and the refinance just happened to be part of the request, so it was not the key issue involved, but it was not disallowed either.
I would recommend that an investor complete his or her exchange and wait at least 2 or 3 months before refiancing unless absolutely necessary. You should always error on the side of conservatism unless you do not have any other choice.
I plan on selling one of my properties in a month or two…I’ve owned it for just under two years. My first mortgage is 360K and I’m currently applying for a second of 150K (should close in a few weeks).
If the sales price is 900K how much money will I have in my 1031? Is it okay (as far as the 1031 is concerned)to be taking a second so close to selling?
Posted by CHRIS IN FL on March 10, 2006 at 09:41:00:
BARBARA, BE CAREFUL WHO’S ADVICE YOU LISTEN TO… YOU MIGHT CAUSE YOURSELF PROBLEMS. I DON’T KNOW ALL DETAILS, AND YOU SHOULD TALK TO A TAX PROFESSIONAL EXPERIENCED IN 1031 EXCHANGES, BUT HERE IS AN ATTEMPT TO HELP. YOU ASKED HOW MUCH WILL BE IN YOUR 1031 ACCOUNT. THE ACTUAL CASH IN IT WILL BE SELL PRICE (900K) LESS PAYOFFS (360K + MAYBE $150K) LESS ANY CLOSING COSTS AND EXCHANGE FEES. AS FAR AS THE EXCHANGE GOES, YOU WANT TO GO INTO PROPERTY THAT IS MORE EXPENSIVE (OVER $900K), AND HAVE A LARGER MORTGAGE ON WHAT YOU PURCHASE THAN YOU HAD ON WHAT YOU SOLD TO MAKE THE EXCHANGE FULLY TAX-FREE (IF EITHER IS LOWER, YOU WILL LIKELY HAVE TO PAY TAX ON A PORTION OF THE EXCHANGE). LASTLY, REGARDING YOUR SECOND MORTGAGE, THERE IS A VERY GOOD CHANCE THAT WILL CAUSE A PROBLEM, THOUGH IT IS A GRAY AREA. IRS ADVISES THAT YOU CAN NOT PULL MONEY OUT SHORTLY BEFORE AN EXCHANGE WITH THE INTENT OF GETTING OUT CASH AND AVOIDING TAXATION ON IT (WHICH ON THE SURFACE IS WHAT YOU ARE DOING). PREVIOUS RESPONSE SAID TAKE OUT A BIGGER SECOND, WHICH YOU COULD EASILY DO, BUT THAT MAY CAUSE YOUR 1031 TO BE DISALLOWED COMPLETELY IN THE IRS’S EYES (ASSUMING THEY LOOKED AT IT CLOSELY). AGAIN, YOU REALLY WANT TO TALK TO A PROFESSIONAL IN THIS ARENA TO DETERMINE SPECIFICS. GOOD LUCK!
If your sale price is $900,000 then you will need to 1031 into 1 or more properties with a total value of at least $900,000. Anything less than that and you will pay taxes on the difference.
You might be missing out on a golden opportunity here. If you owe $360K now and have it under contract for $900K, why not take out a 2nd for more than the $150K. The 360 + 150 = 510, that is a 56.66% loan to value (LTV), if it will appraise out (I’m making an assumption since your selling for 900) then any lender in the world would take that deal. You should be able to push that number up to 70% or even 80% LTV, making it either $630K or $720,000. That is TAX FREE money your talking about. Plus it’s cash that you can then use as your down stroke on your replacements. Go back to your lender, show them the contract for $900K and try and get that 2nd higher. My opinion. Terry
Chris is right on the money. The investor is required to reinvest 100% of their equity or proceeds in order to defer 100% of their capital gain and depreciation recapture taxes. The act of refinancing just prior to the 1031 exchange could result in the amount being pulled out being reclassified as taxable. Our advice would be to refinance and wait at least six months before completing a 1031 exchange (the longer the better). Refinancing too close to the actual 1031 exchange transaction is a risk, especially if you are already under contract.
My apologies, Chris maybe correct (since you are under contract currently). I guess the point I was trying to make is, with that much equity in a piece, why not pull out some tax free cash. If not currently under contract, pulling cash out happens all the time.
Posted by Chris in FL on March 20, 2006 at 07:49:06:
Thanks, Bill. Since you are probably in the know (more than I or most others), please let everyone know if this tidbit is a workable alternative for accessing some of their equity without making their 1031 exchange taxable… I heard or read somewhere, and it makes sense to me, that there is no reason you can’t do your 1031 exchange, and then afterwards, refinance the new property you bought to pull cash out. Excellent loophole to previous problem??? Thanks for your input; maybe this will help some people!