Tax Implication Question

[Calvin Watkins]

So I have had possibly a great idea and want to see what everyone thinks. I would urge tax professionals/ asset managers/ lawyers to respond to this is possible.

I am newer to real estate investing and currently have two homes under my ownership. Both were/are live in flips that get reappraised around October once the flips are done and the market has received all the data it needs to value them. House 1 was a complete gut and also my first home ever. I purchased it under a 5 year ARM loan back in 2019 as it had a preferable rate at the time. I then added a HELOC after the flip to purchase house 2 with no/low money down. Currently the rent covers the payments on House 1 and it is close to break even from a tax perspective.

House 2 was a significantly larger and more luxurious home that was purchased with plenty of room to upgrade and on a 30 year fixed mortgage. As the work is completed the return on the sale would be about $30,000-$40,000. With this being the case I intended to leverage that in to a new property and continue my expansion. 

Instead of doing a 1031 exchange, could I in theory:

1. Open a HELOC on Home 2

2. Use that HELOC to pay down Home 1

3. Sell Home 2 to cover both the Loans on the home

4. Utilize the now open equity in Home 1 to leverage a new property.

If I am thinking of this correctly wouldn't opening the HELOC on home 2 lower the tax liability on the sale of the home? It wouldn't mean a ton in savings but just wanted to know if this is a way to lower tax implications from live in flips that last less than a year.

[Wayne Brooks]

No, you’re missing the basics.  How much money you borrow on a property, or how much equity/cash you walk away with after a sale have No bearing on your taxable capital gain. Financing/loans are ignored, your gain is simply determined by your sales price (less actual closing costs) verses your purchase price plus rehab costs (basis).