Expense allowed for 1031

[Matt Smith]

I am planning to see property A to buy property B using 1031 exchange.

In order to get top dollars for property A, I need to do some home improvements (paint, carpet, etc.)

Is it possible get money from the 1031 exchange sale to "pay me" back these expenses, tax free?

[Dave Foster]

@Matt Smith, there's a couple of ways to do that.  The most preferable way would be to improve Prop A and sell then complete a full exchange at the increased price and buy Prop B.  Immediately after buying Prop B you do a refi or 2nd mortgage on it and take the cash out to pay yourself back for the expenses incurred in improving prop A.

The second way would be to tap equity on Prop A to improve it and then sell it have the new debt paid off as a mortgage lien upon sale and then complete the purchase of prop B in the 1031.

Industry preference is that new debt is taken after the completion of the 1031 so there is no way the service could construe that you took out the debt as a way to access profit outside the exchange.  In your case, if you kept very detailed receipts and tracked the use of the funds borrowed against Prop A you should be all right.  

All things being equal though it's always better to avoid questions rather than be able to answer them.