If you are an NNN investor and are contemplating selling property, you may forget to account for Uncle Sam’s portion of the gain. With the estimated sales price of $1MM, you could look at long term capital gains of close to $750,000 with an estimated tax of over $100,000!
Whereas re-investing the money back into a triple net investment property, a 1031 exchange makes sense, how does an investor extricate some much-needed cash for themselves?
As a NNN property investor, there could be times when you find you might need more cash than what your revenue streams can provide. Maybe you want to make improvements to your current properties. Or, perhaps, you want to buy additional assets to expand your portfolio.
To obtain the funds for repair, extension and, expansion, you could:
- Consider cash-out refinance
- Get an equity partner, or
- Apply for new debt
Pros and cons exist for all the above options. But, under the right conditions, cash-out refinancing could potentially help you obtain equity in the form of cash from net lease properties you already own and, put it to work.
A 1031 Exchange is a tax-deferred exchange that allows a net lease investor to sell one property and then using the proceeds to acquire another property during a specific time period (NNN 1031 investment, NNN Cash Pull out). There is only one difference between doing this and doing a regular sale of a property and it’s that you must pay taxes on any gains you recognize while doing the exchange. Generally, you can defer taxes on any gains. So when doing a 1031 exchange, your property sales are not taxable.
Some rules must be met in order to benefit from this tax loophole. In order for a 1031 exchange to avoid current taxes, two rules below must be met:
- All the equity received from the sale, of the relinquished real estate property, must be used to acquire the replacement, “like-kind” property;
- The total purchase price of the replacement “like-kind” property must be equal to, or greater than the total net sales price of the relinquished, real estate, property.
What this means is that a NNN investor can re-invest all his money back into real estate today without having to pay Uncle Sam.
In a 1031 exchange, the replacement property’s purchase price and equity must be equal or greater than the property being sold. This said, what is UN limited is the ability to refinance and take out cash money.
For example, once the triple net investor completes the 1031 tax exchange, meeting all requirements, he should be able to refinance the replacement investment property outside of the 1031 exchange and withdraw the cash and use it for any purpose at all! As long as you own that property for at least six months following the exchange, an NNN investor can find new debt, tap into the net lease asset’s equity, and likely not face scrutiny from the IRS.(NNN 1031 investment)
(Caveat: If any cash ends up in your account during the 1031 exchange process, the taxes aren’t deferred, and you have to pay them. That’s why a qualified intermediary, or QI, is essential for a 1031 Exchange.)
Cash-out refinance means you’re taking on more debt (NNN Cash Pull out). Sure, you’re getting the extra cash, but if your property’s value declines, you could end up paying more to the lender than what the property is worth. Furthermore, because you took out equity on the property, you’ll have little – or any – left.
Speaking of equity, you should have a minimum 30% equity in the NNN asset for cash-out refinancing to be viable!
