Cash-out refinancing as a tax strategy for retired owners?

Question

A business partner of mine is in a partnership that owns an apartment building worth about $3M.  They've been upgrading units as they've become vacant, which has reduced the monthly cash flow temporarily with expectations for greater cash flow in the future.

The partners are all retired so they are starting to miss the normal amount of income.  Their property manager is recommending that they do a cash-out refinance to (a) increase their income and (b) reduce their equity in the property to reduce exposure in case of a natural disaster, etc.  He's even suggested an interest only loan and make a break even cash flow and take the equity out.

Questions:1. Does this investment strategy make sense for older, retired investors?2. What are the tax implications of taking cash out now rather than later?3. Is there a way to take cash out but distribute it to partners over time to reduce taxes?

Any advice would be appreciated!

Andy Sturm · Answer

1. My concern with this strategy is it sounds like they're just taking the cash out to have as spending money. Doing this to the extent that debt service washes out all cash flow seems very risky. I know you said they feel cashflow will increase in the future, but I would think thats a gamble. Really gambling to close for comfort. If anything out of the ordinary should come up expense wise sounds like there would be no money to cover it unless the owners used their personal money to pay for it. I really like this strategy if the cash from the refi is used to make more money through other investments. Have them refi, go buy another building and combine the cashflows!

2. There are no tax implications

3. If you take the equity out think of it as already the owners money. The owner contributed the funds to buy the property now the owner wants to draw the funds out. Its isnt an expense like a salary employee it is a reduction in equity therefore you pay no tax. An accountant could probably explain it much better than I am.

Dave Ketcham · Answer

@Andy Sturm and @Steven Hamilton II this is valuable input -- thanks!