How to Address the Issue of Equity in a 1031 Exchange
The main concept surrounding the process of a 1031 tax exchange is that an investor cannot draw any cash benefit from the proceeds of the sale of the relinquished property. In case there is any benefit, it will be subjected to capital gains taxing. This logic makes the practice of refinancing with the intention of removing equity from the 1031 replacement property a very challenging one. It has proven a hard task to state clearly which state is acceptable under Section 1031.
In the past, any court case in which it was found that benefits had been collected by a taxpayer from the refinancing of property before being sold in a 1031 exchange were to be assumed to be profits. Through such cases, there emerged a general rule of how similar cases were to be viewed in the future. It is now a common practice to wait for the replacement property o be closed, before the process of refinancing it can start. This has also presented another concern, where people wonder how long they have to wait going forth, before refinancing and taking equity from the replacement property.
If you ask a cautious real estate investor, he/she will advise you to wait, and not for a short while, sometimes not less than two years. This is to be sure you have complied with the requirements of Section 1031. Another trend coming up is one from the more liberal real estate investors who understand that as soon as the buying of the replacement property has been finalized, the 1031 process is over and done with, and its requirements fully met. The see no restrictions as to why they should not substantiate the exchange once this time is over. They do not see the point in waiting for long periods to refinance the replacement property. Expect them to do so once the closing is done.
When an investor new to the processes of the 1031 tax exchange system wishes to know what makes a good waiting period that complies with all the regulations, they usually find it difficult to obtain such information. The difference between the views held by the conservative investor and those who are more liberally inclined speak of a wide disparity in terms of what is applicable. There are other variations in terms of views in between these opposites. When trying to define the issue of equity in a 1031 exchange, one is met with a concept not easy to define. Real estate investors will interpret it in so many different ways. It is therefore advisable to consult a tax adviser specialized n such matters when you wish to decide on such a case. For the sake of your compliance, you will have to work closely with them, so that you make the best decision with regards to your specific case.