Cash out refi my 1031 purchase?

[Tom Camarda]

Can I purchase my 1031 exchange property all cash and then do a cash out refi at closing??

[Dave Foster]

@Tom Camarda, That's a great question.  The jury is evidently still out on this one although it's mostly fear mongering rather than actual masses of case law supported.  But here's the lay of the land.

1. A refinance immediately prior to a 1031 (maybe even in the same tax year) is frequently viewed by the IRS as an attempt to pull profit out without taxation.  And some of these have been disallowed.  There is very little specific guidance in the regs to this but there is a body of case law supporting this claim.   When you do it you leave yourself open to that claim.  So a refi before a sale is not recommended.

2. However, when you do a refinance after a 1031 is complete you are no longer taking profit.  Instead you are accessing equity via debt with payback terms and cost to access that equity.  Your intended use of the money may be exactly the same and the mechanism is the same.  But when done before a 1031 it is suspect immediately.  When done after it is not.

The question is how long after is OK?  The joke in the industry used to be long enough to pick up a different pen to sign the docs.  And not much has changed other than the fear of how grumpy the IRS may have gotten in recent years.  It's also a different story if the refi can be traced to a regular pattern of use solely for normal business operations (as in a brrrr strategy).