Max out HELOC before sell then 1031?

[Weng L.]

Hi All,

Will maxing out HELOC before selling exiting property cause 1031 to be denied by IRS? HUD-1 only shows the amount used to pay off 1st mortgage and 2nd mortgage (HELOC) but not the data of fund drawing from HELOC. So if IRS audits you on this, does IRS require you to provide several months of HELOC statements, or require you to provide receipts to show how the HELOC fund is used towards this property? (If IRS only asks for HELOC statements for e.g. 3 months, I can draw the fund 3 months prior to sell.)

The problem is that if I don't max out HELOC before the sell, it is hard to spend all the money (that is going to 1031 intermediary) within required timeframe, that is why I want to reduce the money that is going to 1031 intermediary by drawing all available HELOC amount before the sell.

I used the HELOC on and off to flip other properties before, but right now the HELOC balance is $0. HELOC was opened over 1 year ago.

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Another question - the capital gain tax that is getting deferred by 1031 is based on sale price and cost basis, correct? i.e. the capital gain tax that is getting deferred is the same no matter HELOC is maxed out or not?

[Bill Exeter]

Hi @Weng L., 

It could. It is never recommended to take out a new loan or draw upon a line of credit or HELOC just before the sale and 1031 Exchange. The IRS could argue that you did not intend to reinvest that equity since you pulled it out just before the closing. They do not generally request HELOC statements. It would most likely occur if they see something that tips them off.

You are still required to identify and purchase one or more replacement properties of equal or greater value.  The amount of outstanding debt vs. equity only changes the way that you finance the new acquisition and does not change the amount of what you must acquire.  

You are correct.  The deferred gain is the sale price less closing costs less adjusted cost basis.