Understanding the Concept of Equity in a 1031 Exchange
It is the foundation of the idea of a 1031 tax exchange, where an investor knows he/she cannot draw any cash benefit from the returns of the sale of the primary property. Should there be any cash benefit, it will be treatable to 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 established in court cases before that any benefits gained by a taxpayer from the refinancing of a property before selling it in a 1031 exchange is to be taken as a profit. 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 has also presented another concern, where people wonder how long they have to wait going forth, before refinancing and taking equity from the replacement property.
If you ask a cautious real estate investor, he/she will advise you to wait, and not for a short while, sometimes not less than two years. They do this in order to be sure they have met 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. They do not see the point in waiting for long periods to refinance the replacement property. Expect them to do so once the closing is done.
When an investor new to the processes of the 1031 tax exchange system wishes to know what makes a good waiting period that complies with all the regulations, they usually find it difficult to obtain such information. The difference between the opinions of the conservative investors and their more liberal counterparts cover a wide area of thinking. There are other variations in terms of views in between these opposites. When trying to define the issue of equity in a 1031 exchange, one is met with a concept not easy to define. Real estate investors are left to treat it as they see fit. It would be best to consult the services of a qualified tax adviser, or a similar legal expert, before making your final decision. Ensure you follow their advise and guidance in your specific situation, to get the best results.