Smart Ideas: Equities Revisited

How to Address the Issue of Equity in a 1031 Exchange

The main concept surrounding the process of a 1031 tax exchange is that an investor cannot draw any cash benefit from the proceeds of the sale of the relinquished property. If for some reason there is some benefit realized, it shall be loaded with capital gains taxes. This general rule has made the practice of refinancing with the purpose of removing equity from the 1031 exchange replacement property a very difficult one to handle. It has proven a hard task to state clearly which state is acceptable under Section 1031.

It has been ruled in previous cases that all the benefits that were gotten by a taxpayer form the refinancing of a property prior to selling it in a 1031 exchange were to be treated as profits. Such scenarios presented the basis of how similar cases would be treated in the future. This is why we see in most instances where the replacement property is yet to be closed, nothing happens until this step takes place, then others can follow, such as the refinancing of the said property. This usually leads to the question of how long into the future should one wait to refinance and take equity from the replacement property.

Some of the most conservative real estate investors will tell you to wait for a long period, two years even, in certain situations. This is to be sure you have complied with the requirements of Section 1031. Another group of less conservative real estate investors believes that once the purchase of the replacement property has been done, the 1031 process is complete. They do not see the reason to worry about the substantiation of the exchange once this period has elapsed. Such investors don’t see the relevance of waiting any longer in refinancing the replacement property. They normally proceed to do this, once the closing is complete.

In case you were looking for a definite guide as to when to proceed with the refinancing of the replacement property, it will be difficult to obtain one. The difference between the opinions of the conservative investors and their more liberal counterparts cover a wide area of thinking. There are more perspectives in between these extremes. The matter of equity in a 1031 exchange remains an ambiguous one at best. Real estate investors will interpret it in so many different ways. It is therefore advisable to consult a tax adviser specialized n such matters when you wish to decide on such a case. Ensure you follow their advise and guidance in your specific situation, to get the best results.

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