Getting Down To Basics with Sales
Understanding the Concept 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. Should there be any cash benefit, it will be treatable to capital gains taxes. This general rule has made the practice of refinancing with the purpose of removing equity from the 1031 exchange replacement property a very difficult one to handle. It is difficult to fully understand to say for sure what condition is appropriate 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. Such scenarios presented the basis of how similar cases would be treated in the future. This is why we see in most instances where the replacement property is yet to be closed, nothing happens until this step takes place, then others can follow, such as the refinancing of the said property. What has emerged as a consequence is the concern of how long into the future does someone need to wait to refinance and take 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. Such a long period, according to them, is to confirm that all the legal requirements of Section 1031 have been met. There is an emerging thought among those less conservative real estate investors where they believe that as soon as the purchase of the replacement property is completed, the 1031 process is done. They see no barriers to any attempt to the substantiation of the exchange once this time has passed. They fail to see the purpose of waiting for any longer in refinancing the replacement property. They normally proceed to do this, once the closing is complete.
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 two extremes in terms of thinking by the liberal and conservative real estate investors span a wide range of thought and perspective. There are many other perspectives and opinions covering the wide space in between these two. The matter of equity in a 1031 exchange remains an ambiguous one at best. It presents a challenge for real estate investors in trying to put it in context. It is therefore advisable to consult a tax adviser specialized n such matters when you wish to decide on such a case. Ensure you follow their advise and guidance in your specific situation, to get the best results.
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