Online Calculator | 1031 Exchanges Make Better Use Of Your Debt

1031 Exchanges Make Better Use Of Your Debt

1031 Exchange

The basic premise behind a 1031 exchange is that that you, the taxpayer, are shifting all of your equity from one property to the next.There are two ways to recover money from your property before or after the 1031 Exchange is completed. 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.
There may be times, however, when you would like to use some of your equity for your own entertainment or investments. A good decision? Probably not, according to IRS v. Garcia.

We have tax case IRS versus Garcia which tells us that the refinance must be done well prior to the 1031 Exchange.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. Cashing out equity, called ‘boot’, is acceptable if you pay taxes on it. Garcia tried to avoid the tax and ran afoul of the 1031 rationale, and the IRS.

Refinancing the replacement property is a way of avoiding the Garcia issue. This is where post-exchange financing comes into play. In post-exchange financing, taxpayers may not want to leave all of 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 statement is used to show that the replacement property is encumbered with new debt via a loan or mortgage. Thus, there is a pool of money you can access after the tax exchange.

The legality of the nanosecond exchange is debatable. There are risks in the nanosecond interpretation since there is no definitive IRS rule regarding how long you have to keep the equity in the replacement property. A more prudent approach would be to keep the money in the replacement property in order to avoid the Garcia trap. When this is the situation, 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.

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