Although 1031 Exchanges are primarily used to shift our equity from one property to another, there are ways of recovering some of that equity for use as leisure or further investment purposes.What is not customarily known is that you can use some of the equity from your property through proper refinancing. However, there are two ways to usurp this premise and cash out some of your equity: pre-exchange refinancing, and post-exchange refinancing. Pre-exchange financing will be discussed first.

In a 1031 exchange, all the proceeds from the sale are supposed to be passed on to the Qualified Intermediary. This prevents you from receiving any cash benefit from the sale; there may be times, however, when you would like to use some of your equity for your own entertainment or investments.
There may be times, however, when you would like to use some of your equity for your own entertainment or investments. A good decision? Probably not, according to IRS v. Garcia.

Garcia was a taxpayer who decided to refinance his property in anticipation of the 1031 exchange.Garcia tried to avoid taxes and ran afoul of the 1031 rationale and the IRS.In order for you to avoid the Garcia issue, you may decide to refinance the replacement property. It can be acceptable to pay taxes or cash out the equity otherwise known as ‘boot’. Garcia tried to avoid the tax and ran afoul of the 1031 rationale, and the IRS.

If you don’t want to encounter the Garcia issue, you should decide to refinance the replacement property. This is a good way for you to take some of that equity out of the replacement property and buy more real estate. Not all taxpayers want to leave their equity in the replacement property – some want to take out that equity and buy more real estate. But, how long should you wait after completing the 1031 exchange before you take out the equity in the replacement property? Most people would wait a nanosecond.

Some will tell you that the time required for the finance is but a nanosecond. The nanosecond refinance is waiting just long enough after the 1031 Exchange to show the IRS through the closing statement that you have reinvested all of your equity into the replacement property. In a separate transaction, a new settlement statement is used to show that the replacement property was encumbered with new debt via a loan or mortgage, then there is a cash payment from the lender to you. Then there is cash payment (after the tax exchange) from the lender to you. What we have is essentially a pool of money that you can access after the exchange.

Whether the nanosecond exchange is legal is debatable. There are risks in the nanosecond interpretation since there is no definitive IRS rule regarding how long you have to keep the equity in the replacement property. The conservative school of thought says to keep the money in the replacement property in order to avoid the Garcia trap. In this case, keep the equity in the replacement property until the following tax year, or until two years have passed from the 1031 exchange to the ultimate refinance.