Are there refinancing restrictions on replacement property after a 1031 exchange?

I recently discussed the issues surrounding a refinance before selling relinquished property in a 1031 exchange. Another question I often field from my clients is when and how they can refinance their replacement property without triggering IRS attention (and potential tax liabilities).

The good news is, with a bit of pre-planning, you can complete a tax-free 1031 exchange and then refinance immediately afterwards. If done correctly, you can receive those refinancing proceeds tax-free, too. The key to avoiding IRS classification of the loan proceeds as boot lies in the timing of the refi.

You should begin the refinancing process only after you close escrow on the replacement property. You should also use a separate escrow account and prepare wholly separate closing documents. Under no circumstances should you roll the refinancing into the deal on the purchase of the replacement property.

If you do, the IRS may assert that the loan proceeds are boot, utilizing the step transaction doctrine. To avoid application of this line of thinking, avoid tying the refinance to the exchange in any way, including any written or oral agreements.

To find out how we can help you find and close on your next 1031 exchange property or to learn more about the exchange process and our qualified intermediary services, please visit our website.