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Refinancing Prior To Exchange
Q:
Kerry,
I ran across your website online and I like the way you think. I have a tax question and I was wondering if you mind answering it. It is my understanding that you do not pay taxes on borrowed money. Well what if you know you are about to sell property and have a bundle of equity built in. Traditionally this would be capital gains and we don’t like those so we would put the money into a tax deferred account (1031 exchange) but with a tax deferred exchange we are not allowed to touch one red dime—it must go towards the purchase of property. What if I was to refinance this property pulling a portion of my equity out. At this point it is equity and borrowed money. Would I have to pay tax on this for the year as income or would it be considered borrowed money of which tax is not owed?
Thank you,
A:
While there have been occasional discussions about making cash taken out of a property's equity in anticipation of an exchange taxable, those have never gotten very far. As it stands, if you borrow money against your rental or investment property, the proceeds are not taxable as long as the refi is a completely separate event from the exchange transaction.
However, if you sell the property, and don't do a 1031 exchange, the relief of debt (paying off the loan) is treated the same as cash proceeds. Many people make the mistake of assuming that only the actual cash received is counted.
If you do a 1031 exchange after having refinanced, there will obviously be less cash to reinvest via your facilitator. This means that the additional amount of the cost of the replacement property will have to be financed with a loan. Basically, the loan on the new property should be at least as much as the loan on your old property. As with any exchange, whatever you miss your target replacement price by will be taxable as boot.
Your personal tax advisor should be able to help you with more specifics for your situation.
Good luck.
Kerry Kerstetter
Labels: 1031
- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 2/10/2005 01:45:00 PM Send this post:
