Many real estate investors sometimes wish to generate some cash during the time of selling a relinquished property. That said, it should be no surprise that property owners plan to refinance the relinquished property before the exchange or refinance after 1031 exchange in order to get cash out of the property. Learn more about refinancing a tax-deferred exchange.
Before you think of refinancing a 1031 exchange, it is worth noting that the purpose of the exchange is to use the equity built on a relinquished property to acquire new property. Refinancing to cash out the equity defeats this purpose, and that’s why the transaction becomes taxable.
While it is possible to refinance a 1031 exchange without triggering tax, you should be very careful before doing it. Considering that refinancing is likely to put cash into your pocket and reduce the amount you are required to pay on the replacement property, the IRS sees it as a way to avoid paying taxes on the cash taken out in the loan.
If you must refinance property planned for a tax-deferred exchange, then make sure to do it at least six months prior to the property going on the market. The IRS will accept refinancing as long as you can establish the refinance has an independent economic substance.
Refinancing a 1031 exchange is generally not recommended. As a real estate investor planning to refinance a 1031 exchange, it is good to discuss plans with your tax advisors before executing the plan. Notably, it is possible to refinance an exchange if it is independent of the exchange. Spire Financial services can help guide you through the process.