When it’s time to move your equity from a real estate investment, there are typically three paths to choose from, each with its own pros and cons. It’s critical that you consider all options and consult with your tax and other advisors before deciding which path makes the most sense for you and your specific situation. However, a brief overview of the three directions will get you started on your journey.
Sell: You can sell the property outright and walk away with your sale proceeds. The downside? You’ll have to pay capital gains tax (assuming the property was held for at least a year).
Refinance: Refinancing a property allows you to pull your equity from the property, which you can then use to invest in another property, increasing your portfolio and maximizing your leverage. Of course, refinancing will involve costs (appraisal, origination fees, etc.) and you’ll need to make sure the refinanced property can service the loan. This is especially critical in periods of rising interest rates.
Exchange: The best way to move your equity is via a 1031 exchange. This allows you to sell your asset, recoup 100% of your equity, purchase a replacement property and defer income taxes. The 1031 exchange is known as the investor’s most powerful wealth building tool! Keep in mind that the replacement property will need to be equal or greater to the sales prices of your exchange asset in order to defer income taxes completely. (If your replacement property has a lower value, it’s still possible to defer a portion of the income tax obligation.)
Real estate investing offers a number of specific benefits to investors, one of which is the ability to tap the equity when needed. However, how you go about it has serious tax implications, so be sure to give full consideration to all of the options available to you and involve your advisors in the process.