Blog

Subscribe to Our Blog

Subscribe to Email Updates

Featured Post

Recent Posts

Tax-free Refinancing Before or After a 1031 Exchange

After posting my recent blog entitled “Can I Refinance My 1031 Property” I received the following question:

“Paul, can I obtain tax-free cash from a rental property by refinancing it?”

The answer is YES - provided several important steps are followed which we will review in this blog.

Many investors who have realized appreciation in their properties fail to consider that the
equity in their properties can be converted to cash that can be spent for whatever they desire such as taking a vacation, buying a new car, or paying for the education of their children. When you obtain funds by taking out a loan, the funds are generally available to you tax-free. Of course, the loan would need to paid back at some time and along the way you would need to make loan payments. Also, if debt remained on the property at time of sale, you would need to replace the amount of debt with new debt on your future replacement property or with cash from outside the exchange. However, the benefits of what you potentially do with the funds might outweigh the costs of the loan.

Timing is Very Important

Tax authorities frown on taxpayers who borrow money immediately before or after an
exchange to simply avoid paying taxes and there have been cases of audits triggered by timing concerns*. While there are no specific sections of tax code that details the length of time required to avoid possible tax consequences, tax advisors in our network generally recommend that any refinancing should not occur within a short amount of time just before or after an exchange. As a further step, any refinancing should not be referenced in sales or 1031 exchange documents as a condition of the sale or exchange. The financing should be completed outside of the time period during which the exchange occurs – and more time before or after is better.

Intent Must Be Other Than Avoiding Payment of Taxes

It is important to document the purpose of the funds that are obtained via a loan to avoid
accusations that the loan was done solely to avoid paying taxes – especially if the loan was
completed relatively close to the 1031 exchange. Valid reasons for seeking a loan could include improving or repairing the property, paying for healthcare or other critical services, paying bills, or investing in other opportunities e.g., other properties, stocks, bonds, etc.

Obtain Support from a Qualified Tax Advisor

If the loan is completed near the time of the 1031 exchange, it is especially important for you to receive support of a qualified tax advisor who will sign your tax returns for at least the year in which exchange will be reported. Any steps that you take to obtain tax free funds and your intent to use the funds should be well documented to reflect that your objectives were other than tax avoidance.

Summary

Through refinancing a rental property, an investor can potentially obtain tax free funds that
may be better utilized than remaining as unrealized trapped equity in the property. While each refinance in your rental property requires a unique analysis keep in mind that time and specific business purpose are a couple of most significant factors staying in good graces with the tax authorities.

Please note that we are not allowed to provide individual tax advice and you should seek the assistance of a qualified tax professional before acting on the information provided in the blog.

Finally, please consider that refinancing of a property can raise the risk of foreclosure in the
event that the debt payments cannot be sustained due to loss of tenants or an economic
downturn.

If you wish to contact a qualified tax advisor for more information about tax free refinancing options – or have other tax deferral or investment questions, please contact us at 408-392-8822 or via email at info@FGG1031.com.

*Fred L. Fredericks v. Commissioner, TC Memo 1994-27, 67 TCM 2005 (1994)
*IRS Private Letter Ruling 8434015

Paul Getty

Paul Getty is a licensed real estate broker in the state of California and Texas and has been directly involved in commercial transactions totaling over $3 billion on assets throughout the United States. His experience spans all major asset classes including retail, office, multifamily, and student, and senior housing. Paul’s transaction experience includes buy and sell side representation, sourcing and structuring of debt and equity, workouts, and asset and property management. He has worked closely with nationally prominent real estate brokerage and investment organizations including Marcus Millichap, CB Richard Ellis, JP Morgan, and Morgan Stanley among others on the firm’s numerous transactions. Paul also maintains a broad network of active buyers and sellers of commercial real estate including lenders, institutions, family office managers, and high net worth individuals. Prior to founding First Guardian Group/FGG1031, Paul was a founder and CEO of Venture Navigation, a boutique investment banking firm specializing in structuring equity investments made by institutions and high net worth individuals. He possesses over 35 years of comprehensive worldwide business management experience in environments ranging from early phase start-ups to multi-billion-dollar corporations. His track record includes participation in IPOs and successful M&A activity that has resulted in investor returns of over $700M. Paul holds an MBA in Finance from the University of Michigan, graduating with honors, and a Bachelor’s Degree in Chemistry from Wayne State University. Paul Getty holds Series 22, 62, and 63 securities licenses and is a registered financial representative with LightPath Capital Inc, member FINRA /SIPC. Paul is a noted speaker, author, and actively lectures on investments, sales, and management related topics. He is author of The 12 Magic Slides, Regulation A+: How the JOBS Act Creates Opportunities for Entrepreneurs and Investors, and Tax Deferral Strategies Utilizing the Delaware Statutory Trust (DST), available on Amazon and other retail outlets.

Your Comments :