May a taxpayer refinance the Replacement Property obtained in a Sec. 1031 exchange?
If a taxpayer pays cash for a Replacement Property through the use of exchange funds held by an intermediary, and thereafter desires to place a lien on the property and pocket the loan proceeds, he/she may nullify the exchange. The IRS may claim that the cash purchase and subsequent refinance were “step” transactions, the effect of which allowed the taxpayer to pocket the proceeds of the sale of the Relinquished Property without paying capital gains taxes. Most commentators advise taxpayers to avoid a refinance within a year of the acquisition of the Replacement Property. If a taxpayer cannot wait a year, then there should be evidence of an independent business purpose behind refinancing the property. Certainly, any refinance of the Replacement Property should be handled in a separate transaction from the purchase, and the subsequent use of the loan proceeds should be documented to prove the independent business purpose of the loan.
