Borrow equity to avoid capital gains tax?

[Nicole S.]

Good Morning BP, 

I've been searching the forums in hopes of my answer but no luck, yet. 

This is my loose understanding: I was told by some investors this weekend I could borrow the equity in my investment property to avoid capital gains tax because there would be "no gain". The property is currently in contract right now and we're set to close on July 11. Has anyone heard of this strategy? 

Purchase Price: $146,950

Sales Price: $215,000

Mortgage Debt: $107,000

Borrow: ~$108,000

I was told that we need to record the borrowed amount with the sale. Who is going to loan me 100% equity?! Certainly not a mainstream bank - does that mean I'm looking at private money? I'd certainly rather pay those rates than the IRS capital gains rate! 

Thanks in advance. I really appreciate any insight. 

[Dave Foster]

@Nicole S., You can certainly access spending money by borrowing against a property  but borrowing money from equity does not relieve you from recognizing gain.  It only creates liquidity and effects the amount you have to pay back.  

There's two issues you ought to think about.

1. If you borrow money now on a property you're closing on soon you'll have all sorts of costs, originations, etc.  And you'll only have the money to spend for a short time since it will have to satisfy the loan when you close the sale.  And of course the big issue - It does not change your taxable gain situation.

2. The way to avoid paying tax is with a 1031 exchange where you sell an appreciated property and use the proceeds to buy another or more than one new investment properties.  In your example you're selling for 215K and you'll have about 107K in cash proceeds and a gain of around 69K.  In order to defer all of that 20K or so of taxes you would need to do a 1031 and purchase at least 215K of real estate (one or more properties) and use all 107K to do so.  If you wanted to take some cash out you can but anything you do not reinvest or any amount you buy down you pay tax on the difference.

I think what your investor friends were thinking of sort of was the fact that  once your 1031 is complete it is perfectly fine to refinance at that point to access liquid cash.  Again this loan does nothing to change your gain situation as you move forward but it is nontaxable at that point as all the gain is deferred in the new properties.