Cash out refinance & 1031 Exchange

I am planning to convert my primary into a rental and probably keep it for 2 - 3 yrs then might 1031 exchange into something else. Before I do that, I am planning to do cash-out refinance (HELOC is another possibility) so I’ll have less amount I need to tax defer.

Does anyone have experienced that sort of situations? From the internet, it looks like IRS is frown upon if you cash out refinance your investment property too close to exchange. But given it is 2 years out plan and refinance even before it becomes an investment property, I am hoping that it will be fine.

I have done both Heloc and cash out many times.

As per primary home refinance, you are supposed to occupy the place from 2 months (least) to 12 months.

Make sure you cash out (do not go heloc if you need finance for next purchase) refi with 30 year fixed well before (12 months preferred or 6 months minimum) before moving out.

Last time, I cashed out 10 months before moving out, and the new lender was catching this point, asked for letter of explanation.

Thanks for the reminder about minimum duration. Have you done 1031 and know impact of refinance?

Also I’m debating between ARM (5/1 - 7/1) vs 30yr fixed. I could see myself doing exchange unless market is in down cycle in 2-4 yrs coz it is really possible.

If you are selling 2-4 year, no point in going 30 year fixed.

I have not done 1031 exchange. Better try biggerpockets, you may get some responses. May be elt1 or ptiemann or manch would have done.

I don’t get it. If it is your primary, why don’t you sell it to take advantage of the 500k capital gain exemption (if you are going to exchange it anyway in near future)?
It seems to be a no brainer to me, but I am sure I probably miss something important…

You are right, I would use the exemption if I could. Main reason is I am actually using that 500K capital gain exemption on another house as well as I haven’t lived in this house for 2 years yet either. Maybe I might actually turn 2 yr in this house and I might consider that if I sell it in 3 yrs down the road.

Why ain’t more people taking advantage of the $500k capital gain exemption?

Isnt the 500K exemption one time only? and it is upto 500k?

So if I make 100K on a house and use this exemption, is the 500k exemption basically gone?

THE EASY ELIGIBILITY RULES: Internal Revenue Code 121, enacted by Congress in 1997, offers up to $250,000 tax-free sales home profits. To qualify, the seller(s) must have owned and occupied their principal residence an “aggregate” two of the five years before the home sale. Occupancy need not be continuous. Nor must the residence at the time of sale. For example, if the seller owned and occupied the home for two years and then rented it to tenants up to three years, the sale qualifies. This tax exemption can be used over and over again without limit. But it cannot be used more frequently than once every 24 months. The method of holding title is not important. For a married couple to claim up to $500,000 tax-free sale profits, only one spouse’s name need be on the principal residence title providing both spouses meet the occupancy test. Or, if title is held in a living trust, new IRS regulations clarify the full tax exemption is still available.

Isn’t one of the axioms from our leader @manch “Buy and hold and never sell”? I think if he hold it until his death as rental, the benefit of prop 13 of low property tax will out gain the 500k easily. But if you 1031, then it is another story…

For prosperity, I talked to 1031 exchange company to clear things up. Here is the short answer: “It will not change the amount/value of the replacement property that you will need to acquire through a 1031 Exchange”.

Longer version is: Net Sale Price is the “magic” number that must be reinvested. You calculate the Net Sale Price by taking the Gross Sale Price (what you sold the property for) and subtracting your routine selling expenses such as broker’s commission, title insurance costs, escrow closing fees, exchange fees, recording fees, etc., but do not subtract the loan payoff, any lender related fees or costs for the payoff, and would not subtract any operating expenses paid through closing like prorated property taxes, prorated rents, HOA fees, etc. Essentially, you own an asset that has a fair market value of $XXX and you must reinvest that same $XXX dollar amount less routine selling expenses. The government is allowing you to defer your taxes as long as you remain fully invested. You will pay some or all of the taxes if you trade down in value or pull cash out of the transaction.


Good info myo.

What’s your game plan for 1031 exchange?
Buy in some other area or a duplex / multifamily for more cash flow?

You will have a larger base for property tax, right?

Correct on property tax as well as cost of selling/buying, 1031 is selling & buying and just deferring your IRS share. My game plan is to diversify into MF at one point, not sure it is in Bay Area or outside. I prefer to keep in Bay area if numbers work for a few reasons. But not opposed to decent location outside of BA to diversify.

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When you do, make sure cash flow is high. Go for 4-plex or apartments. AIM maximum cash flow.

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Yea, I agree. However, 4-Plex are really hot right now. Probably due to attractive residential financing.

I am a newbie. So I need to live at least 5 years to qualify? If I live for 3 years and sell the house I am eligible or not?

This tax exemption can be used over and over again without limit. But it cannot be used more frequently than once every 24 months.

-> Basically I can do this every 2 years and 1 month.

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Correct. Once you stay there for that long, whether you are staying there or rented out the house for the next three years don’t matter. You like moving house every 2 years?

I don’t like to move every 2 years. What I understand I don’t have to wait for 5 years stay. If I just live 2 years I am eligible. Or, live 2 years and one month and rent out 2 years 11 months and sell it.

Yes your assumption is correct. You live for minimum 2 years and sell. Or move out and can rent up to 3 years after you move out and sell, you are eligible. If you rent out, the only thing is you need to recapture the deprecation you deducted during the rental period at the time of selling.

And you can repeat every 2 years.

How do I calculate? I am not expert on tax.

Also, one more question for eligibility.

Also, If I live longer like 7 years, still I am eligible for 500k gain tax free?

For example, lIve 7 years and sell out, house appreciate 700k. So I can take benefit of 500k gain tax free but I need to pay 200k of tax, right?

Thank you.