Can I Pay Off Credit Card Debt at Closing if I'm Using a 1031 Exchange

This question has been raised more than usual recently because of the economic recession that we are all going through, and it makes complete sense. Taxpayers are trying to downsize their own financial position and "de-leverage" by paying down or paying off their debt, including the pay off of credit cards when they sell real estate.

Debt Paydown When Selling Investment Property

It is only natural to want to payoff the credit card debt when you are selling real estate, and to have it done through the closing process. However, it gets more complicated when you are selling investment property and structuring a 1031 Exchange and also want to pay off credit card debt, or any type of personal debt for that matter, through or at the real estate closing.

Personal Debt Payments Create Taxable Boot

The pay down or pay off of personal debt is considered a taxable event when you are selling investment property and structuring a 1031 Exchange. It is technically referred to as cash boot because you are pulling cash out of the transaction and not reinvesting the cash (equity) into your replacement property.

In other words, the payment of personal debt such as credit card debt is a non-permissible expense when paid through a 1031 Exchange transaction. The payment of personal debt therefore means that 1031 Exchange equity has been diverted and is now taxable boot.

Consider Refinancing Your Replacement Property After Acquisition

You might want to consider not paying off the debt at the closing, completing the acquisition of your replacement property and then refinance the acquired property after a few months have passed in order to pay off any personal debt. However, the lender may insist upon the immediate pay off of the debt as a condition to the lender's new loan, in which case you may not have a choice.