Has anyone used this strategy before?

[Thomas Williamson]

Do you get taxed on the money you get from a cash out refi?

I think I know the answer to this, which is no you don't get taxed on the money you get after conducting a cash out refi.  But I would like to make sure.

The reason I'm asking is because we've done quite a few cash out refi's this year alone, and I had a thought recently on one of the houses that we're currently cashing out.

The house is vacant now (tenant just moved out) and it appraised for 155,000.  New mortgage will be 120,000 with current cash out refi.  With the cash out we're picking up roughly 33,000.  That's money that won't be taxed since it's part of the cash out refinance.  Again I think I'm correct on the part, CPA's please advise if I'm not.  

It occurred to me that we could sell the house after the refinance is finished and take the new gain / difference between 120,000 and 155,000 which would be 35,000 (not including closing cost and commissions).  My wife is an agent and could list the house.  

Since we did the cash out refinance on the house prior to selling it, that will take away a sizable amount that would have been taxed.  Our new tax liability will only be for an amount (roughly 25,000).  15% x 25,000 = 3,750 in tax to pay (provided our expenses can't knock that down even more at the end of the year.  

Had we not done the cash out refi, our gain would have been around 72,000.  15% x 72,000 = 10,800.  That's a pretty good difference.

I know many may be thinking about a 1031 exchange.  I think 1031's are great as well.  But, the only issue I have with a 1031 are the time constraints, and whatever you buy is locked up by a 1031 forever.  Meaning (I'm assuming if you sell the property you must 1031 that as well, or pay the original tax penalty).

I know this isn't the greatest strategy, especially when you factor in closing cost, but I was wondering if others have done this in an effort to minimize taxes when selling a property.

I'd love to hear from others who have done this, or have other creative ways of pulling cash out with little tax consequences.

[Dave Foster]

@Thomas Williamson, It's a great idea but .. Hold on.  I don't think everyones on the same page yet.

@Will Barnard and @Atee Thomas are both right as you surmised as well.  When you take out a cash out refi that is not a taxable event.  You are not accessing gain you are borrowing against equity.

However, taking out a cash out refi does not impact the amount of profit when you sell a property.  In fact it is possible to have a sizeable tax bill on a property that you sell with little or no cash proceeds coming out to pay it.

In your example your gain is still going to be around $72K because it does not matter how much cash you  pulled out.  Your gain is determined by the difference between your adjusted cost basis and the net sales price.  Adjusted cost basis is determined by the following formula - purchase price less depreciation plus capital improvements.

So even though you're only pulling out 35K you'll have a tax bill for 72K of profit plus depreciation recapture.

That significant amount might tip the thinking on the time constraints of a 1031 for you.