Hello @Amy Healy
Many of our clients used cash-out refinance in the past for the down payment on their next investment property. A few used HELOCs on their residences too.
What makes cash-out refi's and HELOCs difficult now are the high-interest rates.
You mentioned the possibility of selling your property and buying another property through a 1031 exchange. Here's is when I would choose a 1031 or a cash-out refi::
- 1031 Exchange - You no longer wish to own the property and you believe that a replacement property will bring you more benefits.
- Cash Out Refinance - The property is currently performing well and is expected to continue to do so in the future. If you want to keep the property but reinvest the accumulated equity, that could be a wise choice.
Ultimately, the decision to use a 1031 exchange or refinance and take out equity depends on your individual circumstances and investment goals.
1031 Exchange 45-Day Identification Period Consideration
The identification period for the replacement property is 45 days. Many people believe that they only need to identify (up to) three properties. However, this is a high-risk approach. For example, what happens if you identify a property and then cannot close on it due to inspection issues or other related problems? In such cases, you would lose your tax exemption.
To avoid risks, we coordinate the purchase of the replacement property with the sale of the relinquished property. Our goal is to close on the replacement property within two weeks of the exchange property's closing. This approach allows us to have time to get another property under contract if we run into a problem and cannot complete the purchase, while still staying within the 45-day identification period.
Financing Considerations
The days of finding a lender, and closing with that lender, are pretty much over. The process we are now following is illustrated below.
Immediately after we get a property under contract, We reach out to multiple lenders and request their interest rates and buy-down options. We then select the best option and close with that lender. Using this approach enables our clients to get a positive cash flow. Interest rate buy-downs are available for refinances and HELOCs.
Below is an example showing the benefit of the right interest rate buy down.
The challenge is that we cannot choose the final lender upfront because buy-down options vary almost daily. Therefore, we cannot explore buy-down options until we have the property under contract.
So, as soon as we have a property under contract, we reach out to multiple lenders. We then consolidate the many options and select the best five or ten options and put them on a spreadsheet. I then have a Zoom meeting with the client to go through the various option.
Amy, I apologize for not providing a simple answer. Unfortunately, there is no straightforward answer to your question. Here are some questions that I would consider:
- Is the current investment property performing well? Will it likely perform better in the future? Most importantly, will the rent keep pace with inflation?
- If you did a cash-out refinance using an interest-rate buy-down, what will be the cash flow situation with the current property?
- If you do not believe that rents will keep pace with inflation, then a 1031 exchange may make sense.
- If you choose to do a 1031 exchange, be aware that you cannot use the proceeds for renovating the replacement property. Some clients have chosen to pay taxes on a portion of the 1031 proceeds so that they can use it for renovation costs.
- Work with someone who has a lot of experience dealing with 1031 exchanges. Is easy to trip up and lose your tax deferment.
Amy, I hope this helped.
