1031 Property Exchanges / Tenant-in-Common
Typical investors engage in the management of their own properties and during the course of time may elect to free themselves
from the problems associated with management--dealing with tenants, taxes, maintenance, paying bills, etc) by choosing to
invest in investment-grade professionally managed commercial properties. However some owners of real estate are reluctant
to selling their properties due to capital gains and depreciation recapture. Yet it is possible to defer these taxes and
recapture by purchasing TIC (Tenant-in-Common) properties utilizing a 1031 exchange.
The IRS
Section 1031 allow in a legal way to defer capital gains taxes for those who sell their rental,
business, vacation, and oil & gas properties, and reinvest the net proceeds in other like-kind real estate. A TIC 1031
Exchange allows you to exchange your property for an institutional-quality property in with the potential to generate steady
income, tax benefits and appreciation---The investor no longer has to feel burdened by real estate responsibilities; a manager
is retained to manage the property while the investor enjoys all the benefits of an owner without having management duties.
If the 1031 exchange is executed properly no capital gains taxes may be due until the replacement property is eventually sold.
If an owner investor passes away while owning a property, heirs may receive a stepped-up basis and the capital gains tax could
be completely avoided (You should consult with you tax advisor or attorney for details)
"Real estate has a cycle of its own that has very low correlation with other assets, so it offers
diversification of benefits---It makes the whole portfolio more stable because its performance is not strongly related to or
correlated with the performance of stocks and bonds. Real estate investments will most likely provide both stability and
attractive returns in a potentially volatile investment environment"
-- Youguo Liang, a managing director and head of investment research at Prudential Real Estate
Investors in Parsippany, N.J.
What is Tenant-in-Common?
A Tenant-in-Common (TIC) through a 1031 Exchange is a form of real estate asset ownership in the United States in
which two or more persons have an undivided, fractional interest in the asset, where ownership shares are not required to be
equal, and where ownership interests can be inherited in the event of the death of one holder. Each co-owner receives an
individual deed at closing for his or her undivided percentage interest in the entire property. It is important to note that
a TIC owner has the same rights and benefits as a single owner of property.
Although TIC ownership has been used for many years, its popularity has been increasing dramatically due to the
IRS ruling in March 2002. Exchangers often have difficulty in locating and closing suitable replacement property within the
45-day identification period and the 180-day closing period.
The required investment amount in TIC’s will vary depending on the property. Typically, most TIC’s minimum
investments are around $250,000, a few niche Sponsors cater to investors with as little as $50,000 while some cater to investors
with as much as $500,000 or greater. In addition, the TIC investment holding period can vary from three to five years to
upwards of twenty years for the dissolution of the interest and sale of the property.
- Achieve higher net cash flow with less liability (non-recourse debt)
- Creates access to a larger pool of higher-quality, institutional-grade investment properties
- Allows investors with limited funds to enjoy geographic diversification
- Enables investors to trade time and labor intensive properties for more passive forms of real estate ownership
- Triple-net lease structure provides stable returns
- Interest can be transferred the same as sole ownership property
- Eliminate management obligations
- Generate renewed tax deductions that permit greater tax savings
- Benefit from the extensive due diligence performed
Like Kind - Investment Property Types
"Like-kind" essentially means that you have to exchange your property for another similar property.
As long as both the property to be sold and the property to be purchased are held for productive use in a trade or
business, or for investment purposes, taxpayers are free to purchase whatever type of property they want. —However
you cannot exchange real estate for a partnership interest or interest in a limited liability company or vice versa.
- Commercial
- Office
- Retail
- Shopping Center
- Industrial
- Multi-Family
- Energy
- Other
How a 1031 Exchange Works
- An investor decides to sell investment property and do a 1031 exchange.
- Investor contacts a qualified intermediary (QI) and they enter into an agreement.
- The investor’s property is put on the market for sale.
- An offer to purchase the investment property is accepted and signed by the QI.
- Escrow for the sale is opened, and a preliminary title report is produced.
- The QI sends required exchange documents to the escrow closer for signing at property closing.
- Escrow closes.
- Within the first 45 days after the close of escrow on the sale of the relinquished property, the investor
identifies replacement properties as required by law. This is known as the "Identification Period".
- Within 180 days after the close of escrow on the sale of the relinquished property, the investor closes on one of
the replacement properties which he has identified. This is called the "Exchange Period". This completes the exchange.
No cash – or "boot", as it is known – is taken by the exchanger.
Example of a 1031 Exchange
- An investor buys an office building (a commercial property) for $300,000. After five years the investor can sell
it for $400,000 creating a $100,000 gain. The sale of this property would generate a capital gains tax on the $100,000,
however if the entire sales proceeds of $400,000 were used for the purchase of another property, then there would be no
taxes due at that time.
- An investor owns a home rental property worth $1,000,000 and it has appreciated $500,000. The investor wishes to
invest the proceeds of the sale into two different properties: oil & gas property, and an industrial building. If 1031
exchange is properly executed, the investor can defer the taxes due on the $500,000 gain.
Tenant-in-Common Benefits
TIC's can provide a professional managed, institutionally funded “turn-key” real estate solution with many benefits
to the individual investor such as:
- Achieve higher net cash flow with less liability (non-recourse debt)
- Creates access to a larger pool of higher-quality, institutional-grade investment properties
- Allows investors with limited funds to enjoy geographic diversification
- Enables investors to trade time and labor intensive properties for more passive forms of real estate ownership
- Triple-net lease structure provides stable returns
- Interest can be transferred the same as sole ownership property
- Eliminate management obligations
- Value of property could decline
- Loan default could result in loss of entire investment
- Generate renewed tax deductions that permit greater tax savings
- Benefit from the extensive due diligence performed
Tenant-in-Common Risks
- Tenant-In-Common interests are only available to accredited investors
- Tenant-In-Common interests are subject to the usual risks of real estate
- Tenant-In-Common interests’ cash flows and returns are not guaranteed
- Tenant-In-Common interests involve fees that may offset tax savings
- Tenant-In-Common interests are generally illiquid. There is currently is no secondary market
- Tenant-In-Common interests require a high level of due diligence
- Tenant-In-Common interest risks include failure to meet required completion deadlines as well as
the potential lack of cash flow
- Value of property could decline
- Loan default could result in loss of entire investment
- Tenant-In-Common interests' values can be negatively affected by fees and costs
- Co-owners of Tenant-In-Common properties do not directly participate in the day-to-day management of the properties
- Tenant-In-Common interests may be subject to unfavorable tax rulings which could result in immediate tax liabilities