Equity in a 1031 Exchange
It is the foundation of the idea of a 1031 tax exchange, where an investor knows he/she cannot draw any cash benefit from the returns of the sale of the primary 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.
It has been ruled in previous cases that all the benefits that were gotten by a taxpayer form the refinancing of a property prior to selling it in a 1031 exchange were to be treated as profits. Such scenarios presented the basis of how similar cases would be treated in the future. Nowadays, what people do is wait for the replacement property to be closed, then refinance it at some future time. This usually leads to the question of how long into the future should one wait to refinance and take equity from the replacement property.
Some of the most conservative real estate investors will tell you to wait for a long period, two years even, in certain situations. They do this in order to be sure they have met the requirements of Section 1031. 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. 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. They will do so immediately after the closing.
In case you were looking for a definite guide as to when to proceed with the refinancing of the replacement property, it will be difficult to obtain one. The difference between the opinions of the conservative investors and their more liberal counterparts cover a wide area of thinking. There are more perspectives in between these extremes. The equity issue in 1031 exchanges is normally a gray area at best. It presents a challenge for real estate investors in trying to put it in context. It would be best to consult the services of a qualified tax adviser, or a similar legal expert, before making your final decision. You will need to work closely with them to come up with the best approach that will suit the specific situation you find yourself in.