David and Tom Moore, Equity Advantage, have worked with thousands of investors since the early 1990s. In their straightforward, experience-driven style they answer the questions clients actually call about: Can I use proceeds from my personal home sale to pay off a loan owned by my IRA or 401(k)? When does it make sense to do a 1031 Exchange versus just selling and paying the tax? What are the traps and legal workarounds?
This article distills their answers to frequently asked questions into practical guidance you can use when planning a sale. It covers retirement account rules, prohibited transactions, LLC workarounds, the real purpose of a 1031 Exchange, Section 121 conversions to primary residence, the “swap till you drop” heir strategy, and the critical IRS Rule 1031 G6 on when Exchange funds can be distributed.
1. Can personal proceeds pay off debt on a property owned by your IRA or 401(k)?
Short answer: No — not directly.
If a retirement account owns a property, using your personal funds to pay off that debt typically creates a prohibited transaction because you (a disqualified party) are financially benefiting the plan. The IRS treats these transactions severely:
- With a 401(k) plan, a prohibited transaction generally causes the funds involved in that specific indiscretion to be treated as a distribution.
- With an IRA, a prohibited transaction can cause the entire IRA to be treated as distributed (taxable) as of the first day of the year in which the prohibited act occurred.
That difference alone makes it dangerous to try ad-hoc solutions. Distribution taxes — potentially ordinary income tax plus early withdrawal penalties if under 59½ — can be far worse than capital gains you might otherwise owe on a real estate sale.
2. Is there a legal workaround? Yes — but it changes ownership and expectations
There is an avenue that protects the retirement account and still enables paying down debt: form a brand-new entity (typically an LLC or partnership) and have the retirement plan invest into that new entity alongside you personally.
How that works, in practice:
- The retirement plan contributes the property (and optionally cash) to the new LLC for its ownership interest.
- You (personally) contribute cash to the same LLC for your ownership interest.
- The LLC now owns the property and has cash, which can be used to pay off debt inside the LLC.
Important legal principle: disqualified parties (you and the plan) may invest alongside each other into a new entity — that is allowed. What is not allowed is buying or selling directly between disqualified parties. In short, you cannot have the plan buy from you or vice versa, but both can be investors in a third-party entity.
Trade-offs to understand:
- The plan no longer owns 100% of the property; you now share ownership. Because the property (or the LLC interest) is still owned by the retirement account partially, you cannot personally live in or use the property without triggering prohibited transaction rules.
- To get the property fully into personal ownership later, the plan will have to distribute LLC shares to you over time as in-kind distributions, or the plan holder must take distributions that convert plan ownership into personal ownership — which may have tax consequences.
- For IRAs, distributions are taxed as ordinary income; for 401(k)s there are other distribution rules. RMDs (required minimum distributions) are an additional planning consideration if the plan lacks cash during retirement years.
How can you ultimately end up owning the property personally?
One common pathway is an in-kind distribution of LLC shares over a multi-year period. For example, you might structure distributions so the IRA transfers 20% of the LLC interest to you each year for five years, until you personally own 100% of the LLC. Each distribution is a taxable event and must be planned with your tax advisor.
Bottom line: a creative structure can solve the immediate problem (paying off debt), but it creates a multi-year ownership and tax plan that needs professional coordination.
3. What does a 1031 Exchange actually do? (Taxes deferred, not eliminated)
Simply put: a 1031 Exchange defers capital gain tax when you sell investment property and buy like-kind replacement property. It is deferral — not forgiveness.
Key points:
- A 1031 Exchange defers the capital gains tax that would be owed on the sale, provided you reinvest all equity and debt into like-kind replacement property. If you take money out (boot), that portion is taxable.
- You can keep exchanging indefinitely — sometimes called “swap till you drop.” If you hold properties until death, heirs receive a stepped-up basis which may eliminate the deferred gain entirely for the heirs.
- Moving between property types is allowed (a rental single-family home for a commercial building, raw land for apartments, etc.). Exchange laws focus on the nature of investment, not form.
That said, a 1031 Exchange is an investment decision — not purely a tax decision. You should consider cash flow needs, management burden, retirement planning, and whether you prefer to pay tax now and simplify your life.
4. When does it make sense to skip the 1031 Exchange and just sell?
It depends. Consider these factors:
- Tax exposure magnitude. If your taxable gain is small, the costs and complexity of a full Exchange might not be worth it.
- Retirement accounts. If you have IRAs/401(k)s that will face much worse tax treatment than long-term capital gains (ordinary income + possible penalties), avoiding an Exchange and paying capital gains tax on real estate sale may still be better for your overall tax picture.
- Management fatigue. If you no longer want to deal with property management or tenants, paying the tax to exit real estate might be the right lifestyle decision.
- Offsetting losses elsewhere. Your CPA might advise realizing gains if you have losses to offset them in the same year.
Many investors choose partial Exchanges — they reinvest most proceeds but take taxable cash out (boot) to meet other needs. The Exchange is not all-or-nothing; you can plan a partial Exchange and intentionally accept taxable boot.
5. Converting Exchange property into a primary residence — can you use Section 121?
Section 121 (the primary residence exclusion) allows exclusion of up to $250,000 (single) or $500,000 (married) of gain when you sell your primary residence, provided you meet the 2-of-5-year ownership/use test. But rule changes and IRS guidance have limited strategies that used to work.
If you acquire property via Exchange and then convert it to your primary residence, you must be careful about “non-qualified use” rules. Generally:
- You can convert an investment property into a residence, but to take full advantage you must satisfy IRS seasoning expectations. The IRS looks at intent and the pattern of investment vs. personal use.
- Revenue Procedure guidance and subsequent law generally means you must hold the property for at least five years and occupy it for at least two of those five years to claim portion of Section 121 exclusion without substantial proration for prior nonqualified use.
- Don’t assume a short rental period then quick conversion will wipe out deferred tax from the Exchange — IRS rules disallow many short-term conversion tactics intended solely to eliminate tax.
In short: converting an Exchange-acquired property into your residence can work as an “end game” (your forever home), but don’t plan on it as a short-term tax avoidance move.
6. IRS Rule 1031 G6 — When can you access cash during an Exchange?
Rule 1031 G6 addresses constructive receipt and when Exchange funds can be distributed. Equity Advantage and similar professional facilitators adhere strictly to the timing rules to protect all clients.
Basic rules on cash access during a delayed Exchange:
- If funds from the relinquished property come to the Exchange accommodator, you usually cannot get them back immediately without jeopardizing the Exchange (constructive receipt).
- If you want cash at closing, you must arrange that at closing as “retained taxable proceeds” — spelled out ahead of time so those funds never enter the Exchange account.
- If funds are already in the Exchange account, the accommodator can release those funds only after either:
- The 45-day identification period expires with no identified replacements (then funds can be released after day 45); or
- The investor has acquired all properties they are entitled to acquire per the identification form — if the ID form lists three properties but you state you will only acquire two, once you acquire those two the Exchange is final and remaining cash can be released.
Why does this matter? If a facilitator improperly releases funds on demand, every client of that facilitator becomes vulnerable: the IRS could find constructive receipt and disallow many Exchanges. That’s why choosing an experienced, compliant facilitator like Equity Advantage matters.
7. Practical steps — what to ask and when to involve professionals
Experience matters. David and Tom emphasize that most calls with clients are 30–60 minutes because tax and Exchange issues require detailed, individualized questions. Before listing property for sale, consider these steps:
- Talk to your CPA and Exchange facilitator early. Don’t wait until closing to figure out tax exposure or Exchange structure.
- Know your basis and expected capital gain. Equity is not the same as taxable gain.
- Decide if you want full deferral, partial deferral (take some boot), or to pay tax now and exit the market.
- If a retirement account is involved, run prohibited transaction checks and consider entity structures (LLC partnership) if you need cash to pay down debt.
- Never close a sale or buy a replacement before the Exchange is structured with your accommodator — a Reverse Exchange is an option if you need to buy first, but it is more costly and must be set up ahead of time.
8. Real-world anecdotes and closing advice
David and Tom draw on decades of experience — they compare learning Exchange rules to learning to handle tough ocean conditions: you can read rules, but experience teaches you the nuances and the right questions. They’ve seen clients try shortcuts that end up costing far more in taxes and penalties than the perceived savings.
Two final reminders:
- 1031 Exchange is a tool — use it when it aligns with your investment and life goals, not purely to avoid tax at all costs.
- Work with experienced professionals: CPA, attorney, and an Exchange accommodator you trust. The small fee for good facilitation is tiny compared to the cost of a poorly executed Exchange or a prohibited transaction.
Make the decision that fits your life and tax picture
Whether to do a 1031 Exchange or simply sell depends on the tax math, your retirement account exposure, your desire to continue owning and managing property, and long-term estate planning goals. You can’t safely use personal proceeds to pay debt on a retirement account property without creating prohibited transactions — but structured solutions exist if you’re willing to accept the ownership, distribution, and tax consequences that follow.
David and Tom Moore (the 1031 Exchange Bros) recommend planning early. If you have specific questions on IRAs, 401(k)s, 1031 Exchange structuring, G6 cash rules, or converting Exchange property to a residence, reach out to your tax advisor and Equity Advantage, qualified Exchange facilitator, and get the answers before you list.
The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 503-635-1031.
