If you’re managing one or more multifamily properties yourself, you may be at the point where you’ve grown weary of what some investors have dubbed “tenants, trash, and toilets.”
You’ve probably gotten more than your share of early morning or late evening maintenance and complaint calls from tenants, chased down late rent checks on a regular basis, and hired and fired more than your fair share of maintenance people.
You may be longing to sell that property or properties and get out from under the extreme claims on your time and resources and become a passive investor in something more benign. However, the thought of what selling your property would cost you in taxes makes you break out in a cold sweat.
Well, what if I told you there was another way; a way that makes it possible to sell the property that’s causing you so many headaches, buy a piece of another commercial property, and do it without paying capital gains tax?
It may sound too good to be true, but it isn’t. Utilizing a 1031 Tenants in Common Exchange allows you to do all those things.
It’s one of the best ways for a savvy investor to gain ownership in one or more high-quality properties while keeping their money working for them and avoiding the frustrations of managing properties themselves.
A Tenants in Common Exchange is a form of real estate asset ownership in which two or more parties have undivided, fractional interests in that asset. In this arrangement, ownership shares do not have to be equal.
In a Tenants in Common (TIC) structure, each of the co-owners gets an individual deed at the time of closing reflecting his or her undivided percentage interest in the entire property. This means that a TIC owner has the same rights and benefits as a single owner of a property.
Although TICs have been around for a while, they have begun to gain more favor with those doing 1031 Exchanges. That’s because so many Exchangers have found it nearly impossible to locate replacement properties within the strict 45 days given by the IRS. The IRS seldom gives additional time to meet this requirement.
Using a TIC gives investors a lot more flexibility and diversification. Let’s say, for example, that you sell a small apartment building you’ve owned for 10 years and your equity is $300,000. Depending on any debt you still carry on the property, you could probably purchase a new investment of around one million dollars.
While that may seem like a lot of money to work, there is a chance that you still could not qualify to purchase an A- class property on your own. Investing that $300,000 in a TIC, though, could get you a million dollar interest in an institutional grade property.
Using a TIC you could become a passive investor in something like a luxury hotel or resort, office complex, apartment complex, or medical facility. This diversification could potentially assist you in reducing risk and increasing the value of your portfolio.
Just as in everything else the IRS does to “help” taxpayers, there are a bewildering number of rules and regulations associated with TIC 1031 Exchanges. Failure to follow each and every one of these rules to the letter could mean that you won’t be able to defer your capital gains and depreciation recapture taxes. You might even get fined.
There are 5 general requirements to which every potentially successful TIC 1031 must adhere.
1. Property relinquished MUST have been held as an investment or used in the property owner’s business or trade.
2. The transaction must use a “Qualified Intermediary” (QI) as defined by the IRS, as the designated seller. The QI will hold all proceeds from the sale of the property being relinquished.
3. There is a 200% Rule that says any number of replacement properties may be identified but the aggregate value of those properties cannot exceed 200% of the value of the Relinquished Property.
4. At least three like-kind Replacement Properties must be identified in writing within a 45 day identification period. The 45 day rule includes weekends and holidays. Exceeding this by even one day can cause the entire exchange to be disqualified.
5. The full 100% of proceeds from the sale of the Relinquished Property must be invested and the value of the Replacement Property must be equal to or greater than that of the Relinquished Property.
In the event that the 3 property and 200% Rule do not apply, the aggregate market value of the commercial properties being acquired in the TIC 1031 Exchange must comprise at least 95% of the total fair market value of all identified properties.
Once a Replacement Property has been chosen, an investor has 180 days from the date the Relinquished Property was transferred to the buyer to close the new property.
WOW! That’s a lot to take in, isn’t it? And that’s just the basic requirements.
The IRS, after all, is stuck serving two masters. On the one hand, they want to encourage people to invest in property and help grow the economy. On the other hand, they are attempting to squeeze out as much tax revenue as possible.
They deal with this tension in the only way they know how: by creating as many arcane and confusing rules and regulations as they can to discourage all but the smartest investors from taking advantage of this incredible tax-saving structure.
A 1031 Exchange can be an awesome tool for investors, allowing them to ditch bothersome and underperforming properties in favor of higher quality investments, helping them create potentially better income than their past investments, and allowing them to defer taxes.
However TICS are not something to be undertaken without the help and guidance of professionals who specialize in this type of asset ownership structure. You don’t ever want to try this alone, no matter how seasoned an investor you may be.
At Grocapitus, we maintain excellent relationships with a number of experts in the area of TIC 1031 exchanges. If you are an investor who is thinking about doing this type of exchange, contact our office and we will be happy to help you find the right expert who will increase your chances of success.