Sell, 1031, or Refinance?

What this page does, and what it leaves to a separate review

This page does not decide whether you should act. That needs saying at the top, because the three routes are usually introduced in the middle of an argument for taking one of them.

What this page does is lay the routes side by side on the same set of consequences — ownership, tax, cash, leverage, the clock — so that each one is comparable to the others rather than to a feeling. That is a narrower job than it sounds, and it is the job that is usually skipped.

The question of whether this property still deserves the capital tied up in it is a separate review, and it depends on this one. That review is Does This Property Still Deserve My Capital?. The order can look backwards, so here is why it runs this way round: a verdict on whether a property still earns its place is not something you can act on until you know what changing your mind would cost. The routes and their costs are the input to that review. Deciding whether before knowing what it takes is how an owner talks themselves into a transaction and finds out afterwards what it involved.

So this page covers the routes, and that review gives the verdict.

The first fork is keep or dispose

Here is the difference that shapes the whole comparison, and it is not a tax distinction.

Selling and exchanging are disposition routes — the asset leaves your hands. Refinancing is a hold route — you keep the asset and borrow against it. That is a difference in what you own at the end, and everything else follows from it.

It matters because listing three options side by side hides it. Line up "sell, 1031, refinance" as three options and they look like three answers to one question. They are answers to two different questions: how should I let this go? and how should I keep it and get at some of the capital? An owner who has not settled which of those questions they are actually asking can spend a long time comparing routes that are not alternatives to each other.

It also matters because it is what makes the fourth route visible.

The four routes

Four, not three. Each is described here by what it does — not by when you should take it.

Sell — dispose, and recognize

You transfer the property and take the proceeds. It is the only route that ends every obligation attached to the property and turns your position into cash you can use anywhere — on a conventional cash sale, all of it at closing.

If you take back a note instead — the buyer pays you over time on a loan you carry — it is still a sale, but an installment sale stages the cash, and generally the recognition of gain, across years (any ordinary-income depreciation recapture, such as on §1245 components a cost segregation study identified, is still recognized in the year of sale, even though the cash arrives later); Suspended Losses and the Year You Sell covers what that staging does to a suspended loss balance the sale releases. Recognizing gain means reporting it as taxable income. A suspended loss balance is past rental losses the passive-loss rules did not let you deduct, carried forward.

A conventional sale is generally a fully taxable disposition, which means gain is generally recognized in the year of sale. How much and of what kind is not this page's subject. What you keep depends on your adjusted basis (roughly: what you paid, plus improvements, minus depreciation). The gain that results is characterized in layers, meaning it is split into tax categories: some of it potentially at ordinary rates, some in the unrecaptured §1250 category (the part attributable to straight-line depreciation on the building), some as long-term capital gain. Adjusted Basis covers the basis and Depreciation & Gain Character at Sale covers how the gain is sorted into those categories. The assembled bill — the layers, the rates and the order they land in — is the subject of What the Tax Bill Looks Like When You Sell. This page names the shape of the bill on purpose; working out the number here would duplicate those three pages.

What is worth holding onto at this level is that a sale is the route where the tax consequence is immediate and largely settled, rather than carried forward.

A qualifying 1031 exchange — dispose, and defer what qualifies

You dispose of the property and acquire replacement property through a structure that, where it qualifies, lets you postpone recognizing gain rather than recognizing it now.

Two phrases in that sentence matter most. "Where it qualifies": an exchange is not a tax treatment you elect. It is a transaction that has to satisfy conditions, and a failed exchange does not defer recognition. And "postpone": the gain does not disappear. It travels into the replacement property through a substituted basis, meaning the replacement generally takes over your old property's basis, with adjustments, instead of starting from its purchase price. That is why the deferral is real and temporary at the same time.

Two consequences belong in this comparison and nowhere else on this page:

• Your capital largely stays in real estate. An exchange is built to keep the deferred portion of your equity invested in replacement property rather than to hand it to you. You can receive cash — but that cash is boot (anything you receive that is not like-kind replacement property — cash, or a net reduction in your debt), and it generally recognizes gain to the extent of it. So cash is available at a price rather than unavailable: the more you take, the less is deferred.
• A qualifying exchange generally does not release a suspended passive loss balance, because where gain stays deferred, the recognition condition that a release under §469(g) requires is not met. (That provision frees suspended losses when you dispose of your entire interest in a passive activity, to an unrelated person, in a transaction in which all realized gain or loss is recognized.) But that rule turns on whether all realized gain or loss was recognized, not on the §1031 label. So in an exchange that recognizes all of it, a release is back in play, and the release conditions have to be checked rather than assumed away. Whether any of this matters to you depends on the balance you are carrying, and Suspended Losses and the Year You Sell covers the rule.

Everything about how an exchange qualifies and how it works mechanically — the property and use requirements, the two deadlines, boot and net debt relief, the intermediary, the substituted basis — is covered in The 1031 Exchange. This page names the route and leaves the mechanics there.

Refinance — hold, and borrow against it

You keep the property and place new debt on it, generally larger than the old debt, and take the difference in cash.

Borrowing against property you continue to own is generally not a disposition, so a refinance does not by itself put a gain on your return. That is not the same as being free. Cash from a refinance is borrowed, and the borrowing arrives with a repayment obligation that outlasts whatever you spend the money on. Whether you can deduct the interest can also depend on what you use the borrowed money for. That is a question for Financing and for your own advisor, not an assumption to carry into the comparison.

The real limit on this route is that it has to work as a loan: at today's pricing, at the debt-service coverage your property can support (how comfortably its income covers the loan payments), and with reserves left standing. That test is answered in Should I Refinance?; this page only says that accessing equity while holding is a route, not whether this particular loan is available to you.

Do nothing yet — hold, unchanged

The fourth route is to keep the property as it is.

This is not the absence of a decision, and putting it in the list changes the comparison. If the property still earns its place and what you need is cash rather than a way out, disposing of the asset to solve a cash need is an expensive way to raise money. And if the pressure is a number you dislike rather than a need, you may not need any route at all.

Doing nothing has consequences too, and they are the quiet kind: the capital in the property keeps earning whatever it currently earns, which is what Cash Return on Current Equity & the Wealth Engines measures; nothing is triggered, nothing is deferred, and no deadline starts. A comparison that leaves this route out has assumed a transaction before the reader has agreed to one.

What each route costs that the headline does not show

Every route has a cost that is invisible when the routes are named but not compared.

None of these disqualifies a route. Each is the kind of thing an owner can end up discovering only after committing.

The dimensions the comparison runs on

Once the routes are on the table, they get compared across dimensions — and tax is one of them rather than the frame around them.

• Ownership. Do you still own the asset afterwards? Two routes say no, two say yes.
• Liquidity. A sale is unrestricted cash — at closing on a conventional sale, staged across years where you take back a note. A refinance is borrowed cash with a repayment obligation. An exchange is designed to keep the deferred portion invested rather than to return it to you as cash — what you do take is boot and generally recognizes gain to that extent. Doing nothing produces none.
• Leverage. A sale ends the debt. An exchange does not inherently end it, and the debt can rise, fall or disappear — there is no requirement to replace it, though a net reduction in liabilities can create boot. A refinance increases it. Doing nothing leaves it amortizing.
• The statutory clock. A deferred exchange is the only route here carrying statutory deadlines, one to identify the replacement property and one to receive it, and they are strict. Every route has practical timing — contracts, financing commitments, closings — but only one has deadlines the tax law itself sets.
• Reversibility. Two routes cannot be undone. A refinance can eventually be refinanced again, at whatever the market is then. Doing nothing preserves every option including the ones you have not thought of.
• Concentration and operating burden. Exchanging into something larger keeps the capital concentrated in real estate and may increase the work of running your portfolio. Selling reduces both. These are facts about your portfolio, not tax facts, and they are frequently the deciding ones.
• What replaces it. If redeploying is the direction (moving the money into another property), the replacement property has to deserve the capital on its own terms — and after a sale, that capital is your redeployable equity, what is left after the loan payoff, the selling costs and the tax, not the equity on paper. That is a Deal Analysis question and always has been.
• Tax consequences. Below.

Where tax sits

Tax belongs in this comparison. It does not belong at the front of it, and the reason is mechanical rather than philosophical.

For this comparison you need the direction of each route's tax result, not the dollars:

• A sale is generally a fully taxable disposition and generally recognizes gain in the year of sale.
• A qualifying exchange can postpone recognition of qualifying gain, in whole or in part, with the deferred amount carried into the replacement property's basis rather than erased. Boot generally recognizes gain to the extent of it.
• A refinance is generally not a disposition at all.
• Doing nothing recognizes nothing and defers nothing; the position simply continues.

Those four shapes are enough to compare routes. The dollars are computed on your own facts, and what a sale actually assembles to — the layers, the rates, the released suspended losses if the disposition qualifies, and the order it all lands in — is the subject of What the Tax Bill Looks Like When You Sell.

Here is the failure this ordering is designed to prevent. The route with the smallest immediate tax consequence is not, by that fact, the best route. If you lead with tax, the comparison ends up chasing the smallest bill. An owner exchanges into a property they would not otherwise buy because the deferral felt free, or refinances into a payment that breaks the cash flow because the cash felt like profit, or declines a sale that was right on every other dimension. In each case the tax consequence was the smallest available and the decision was still wrong, because a tax result is a consequence of the asset you end up holding — not a description of it.

Who validates each route

This page chooses nothing, and that is by design. Each route is checked against the relevant guidance:

What this page adds is the one thing none of those guides does on its own: putting all four routes on the same measures, so you can tell which question you are actually asking.

A word on independence

No exchange provider, intermediary, lender or other transaction provider paid for or influenced this guide. That matters here more than on most pages, because every route in the comparison has someone who earns a fee when it is chosen — and the fourth route has nobody at all. A comparison written by a party to one of the transactions tends to have three options in it.