Real estate bootstrapping is generally associated with startup funding. However, bootstrapping could help drive a 1031 exchange, especially if you need extra liquidity to acquire a replacement property in exchange for a relinquished one. Bootstrapping might help you complete an exchange without adding the complexity of loans or outside investors.
What is Real Estate Bootstrapping?
Also known as self-funding, bootstrapping involves buying real estate with creative financing and your own resources. These might include credit cards, cash on hand, or money from relatives and friends.
When used as part of a like-kind exchange, bootstrapping can provide capital and liquidity that could help you meet IRS-mandated regulations and timelines. Through a 1031 exchange, you sell investment real estate (relinquished property) and reinvest the proceeds into like-kind real estate (replacement property).
Bootstrapping might be helpful if the relinquished property you sell has less value than the replacement property you acquire and you need additional liquidity to fill that gap.
Other bootstrapping tools might include the following:
Leveraging existing equity: You could use equity from a property you own to help meet the requirements of a 1031 exchange. Cash-out refinancing can add capital to your efforts.
Seller financing: Negotiating a deal with the seller of your replacement property could help reduce your cash outlay. In this situation, the seller finances the property deal, and you repay the amount over time. If you decide on this strategy, ensure the financial structure meets the 1031 exchange requirements.
Bootstrap Risks
While bootstrapping can be a way to add capital to certain like-kind exchange transactions, it’s essential to be aware of the challenges involved, such as:
Complexity: Bootstrapping can involve complex arrangements that must conform to 1031 exchange rules. All transactions must be properly documented and within the IRS's mandated timelines.
Market risk: Any replacement property you acquire is at risk from market downturns. If you use all your cash reserves or property equity as part of a 1031 exchange, a market decline could devalue the replacement property, leaving you without much capital.
Bootstrapping, Liquidity and Exchanges
While the idea of a 1031 exchange is to keep the value of the relinquished and replacement property values consistent, this might not always be possible. This is where the creativity of bootstrap financing might help. Using your financial resources, property equity, or seller financing can help fill liquidity gaps that might otherwise disqualify a like-kind exchange.
However, simply throwing cash reserves at the issue won’t work. Check with your Qualified Intermediary and tax advisor to ensure that bootstrapping tools are permissible within the IRS’s mandates.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
