Rookie Reply: Can I Cash-Out Refi After a 1031 Exchange?

Ashley Kehr:
This is Real Estate Rookie. Episode 120. My name is Ashley Kehr, and I am here with my co-host Tony Robinson. And we are in…

Tony Robinson:
Las Vegas once again. So Ash and I have our nice little setup in the living room area of the Venetian Hotel. So if it looks a little different, that’s why. But we love recording in person together. It’s like a different energy, different vibe. We can be in the same space. I feel like the conversations … This is our third episode that we’ve recorded today and the conversations with the guests, I feel like just have so much more flow to them because we’re sitting with each other.

Ashley Kehr:
Right, yeah. And it’s more of a conversation than an interview. So we’re going to coin this Rookie Road Trip and we’re going to go to different cities and interview-

Tony Robinson:
We will figure out where we’re going next. I’ve always had Paris on my list. You think we can find some rookies in Paris?

Ashley Kehr:
With COVID restrictions it might be hard to travel to Europe right now, but yeah, sure. I’ve been there once, but it was a long time ago. So, we’ll go again.

Tony Robinson:
We’ll figure it out.

Ashley Kehr:
Okay. We’ll do an episode on international buying property.

Tony Robinson:
There we go.

Ashley Kehr:
Internationally. [crosstalk 00:01:03].

Tony Robinson:
This is global.

Ashley Kehr:
Yeah, yeah. Okay, so today we are going to do a rookie reply question from the Facebook page.

Tony Robinson:
All right. And I got it on my phone here. So today’s question comes from Vince Rayez in the Real Estate Rookie Facebook group. So again, if you guys have not joined the Real Estate Rookie Facebook group, you are doing yourself a disservice. 30,000 plus members in there and it is honestly one of the most active, one of the most engaged real estate Facebook groups that I’ve ever been a part of. Anytime I try and go in there to answer somebody’s question, I usually can’t be because there’s already 10 or 20 good answers to the question. So if you want community [inaudible 00:01:38] support, that’s a good place to go. But anyway, that’s where today’s question comes from. So today’s question comes from Vince and Vince’s question is, “I’m going to be doing a 1031 exchange. Can I do a cash out refinance on the second property to get most of the funds or will I still be liable for taxes? Thanks in advance.” Have you done 1031 exchange yet?

Ashley Kehr:
I have not, but for the investor that I worked for, I did a couple with him. Do you want to just explain briefly what a 1031 exchange is?

Tony Robinson:
A 1031 exchange is literally section 1031 of the IRS tax code which allows you to avoid paying capital gains taxes on the sale of an investment property if you use those proceeds to buy another property. Now there are some limitations and things you can and can’t do, but that’s the general gist. And a lot of people use it because it allows you to avoid paying those taxes. So we actually just sold a property about 40 days ago in Joshua Tree and you got 45 days to identify what they call a replacement property. So you have 45 days to identify the property you’re going to purchase with the proceeds from the other sale and you get 45 days to buy one. So we’re in the middle of that right now. Now, the question is, can you use a cash out refinance on the second property to avoid paying taxes? And the short answer to that is yes.

Tony Robinson:
It’s something that we’ve been looking at doing with our 1031 exchange was essentially burring another property with the proceeds from the 1031. So say for example that you have $100,000 from your 1031, you go out and you pay, I don’t know, cash for a property that costs $50,000 and you spend the other $50,000 renovating it. So you spend all your 50,000 … oh wait, no, you know what? That won’t work actually. It won’t work on a burr unless you come out of pocket for the rehab because you have to use the entire proceeds-

Ashley Kehr:
For the purchase.

Tony Robinson:
For the purchase. So I guess it wouldn’t work on a burr in that sense, but if you paid cash for the property and then you paid out of pocket for the rehab, you could still do the burr that way.

Ashley Kehr:
Yeah. Or you can use the proceeds from the sale of the first property as the down payment and get financing and then do your burr and then you just refinance again out of it. So you’re paying the closing cost twice, but if that gets you into the property and the numbers still work, you can do it that way.

Tony Robinson:
And probably still cheaper than paying taxes on whatever it was you would have done.

Ashley Kehr:
One thing you said too was avoid the taxes and really you’re deferring them.

Tony Robinson:
True.

Ashley Kehr:
So just to clarify, that if you eventually sell, then you do a 1031 exchange into one property, then another property, and you keep doing these sales and upgrading into bigger properties and better cash flowing properties maybe, if you eventually sell and don’t do the 1031 exchange that will trigger the taxes to be owed. So it’s not like once you do a one 1031 exchange, those taxes are done forever. You still might pay them.

Tony Robinson:
That’s a good point. But what a lot of investors do is they call it swap until you drop. So you essentially just keep 1031 for the rest of your life. And then if you do that, then you never have to pay taxes. I do think there are some repercussions, like if it gets passed onto your heirs or something like that, I think there is a recapture.

Ashley Kehr:
Yeah, like the tax basis for them or something. But I’m not too knowledgeable [crosstalk 00:04:50].

Tony Robinson:
We are not tax professionals.

Ashley Kehr:
I was at a [inaudible 00:04:54] at one time, a long time ago, but I don’t remember.

Tony Robinson:
Don’t take this as professional advice. This is just two people sitting in a hotel room in Las Vegas giving you our best opinion of what’s going on.

Ashley Kehr:
The day after a pool party. So, with the 1031 exchange, definitely something that can really help you build wealth. So you’re upgrading into properties. One thing to remember when I did the 1031 exchanges for this other investor was that you have to use an intermediary. You go to somebody who, basically it’s a 1031 exchange company, and you pay them 1200 bucks or a fee and they handle the 1031 exchange for you. Another couple of things I remember is that you have to, when you do the 1031 exchange, it has to go into the same entity that sold the property and the ownership interest has to stay the same for two years. So if me and Tony own a property and we sell it, that the funds from that, Tony just can’t take some money and buy something and I just can’t take it and buy something. We have to go and use that LLC to purchase another property together and keep that ownership interest. I believe it’s two years that you have to keep the same ownership and can’t change partners.

Tony Robinson:
Yeah. Those are really good points. The other thing that I recently found out in doing ours is that you don’t necessarily have to use all of the funds. Say that you get a $100,000 and you only end up spending 70 of that, then the 30,000 gets released back to you from the intermediary and then that’s what you’ll end up getting taxed on is that 30,000 as opposed to the entire 100,000. So there are some nuances there, but it is a really powerful tool. Just to give you guys some background, we had a property, we spent like, I don’t know, I think our down payment was … Our total cash of closing this house was like 35, 36, I think maybe $38,000. We sold it and the goal is that we’re going to take that $38,000 investment and we should be able to purchase a property that’s close to $900,000.

Tony Robinson:
That’s the power of the 1031 exchanges, that you can take a little bit of money, put it into an asset, let that asset value appreciate over time, sell and then go into something much bigger that produces even bigger cash flows.

Ashley Kehr:
Especially in today’s market right now, you’re seeing appreciation really accelerate in a lot of markets. And that’s a great time to … for me, for example, I got rid of a little duplex that appreciated so much since 2018 and I’ve really done nothing to it, but it was a headache property and this was time to get out of it and sell it.

Tony Robinson:
And even with how great the market is, I still cannot sell this house in Shreveport. So if any of you are interested, you know where to find me.

Ashley Kehr:
I’m actually disappointed because the last episode we just recorded it here with our guest, Jay. We did not mention that property for sale.

Tony Robinson:
We did not.

Tony Robinson:
But we did in the previous recording, so. Well, thank you guys so much for joining us today. I’m Ashley @wealthfromrentals and he’s Tony @TonyJRobinson on Instagram. Make sure you guys check out our YouTube channel, Real Estate Rookie on YouTube. A new video is released every single week that are specifically tailored to rookies. Thank you guys and we’ll be back on Wednesday with one of our guests.