If you hold real estate as part of your investmentportfolio, you are no doubt familiar with Section1031 of the IRS code. An enormous amount ofwealth has been created in this country as aresult of property owners using the 1031 exchange toreplace appreciated investment or business propertieswith larger or more desirable properties, while deferringcapital gains tax on the appreciation.
Typically, the 1031 exchange involves nonresidentialproperty, which has appreciated and is no longergenerating satisfactory cash flow, being exchanged fora similar property that produces better income.Principle obstacles to a 1031 exchange include uncertainavailability of suitable replacement propertiesand rigid IRS guidelines that must be followed toqualify for preferential tax treatment.
Karl H. Romero, CFP®, a registered principal, citesthe example of a physician who owns a rental condominiumthat is now worth $500,000. Selling it and purchasinga replacement property that provides a betterreturn appeals to the doctor, but there is a short supplyof suitable replacements. Romero suggestsconsidering a tenant-in-common (TIC) 1031 exchange.Here, investors purchase interests in premium propertiesthat are managed by a real estate sponsor.
Patricia DelRosso, president of Inland Real EstateExchange Corp, cites the following advantages to theTIC 1031: Investors have access to otherwise unavailable,corporate tenants such as WalMart, Walgreens,Disney, and Kohls, and such tenants reduce the risk ofnonpayment and tenant turnover.
Another benefit of the TIC, DelRosso says, isdiversification. An investor might purchase three differenttypes of properties. Diversification throughgeography is also an option for investors.
Another consideration is liquidity, especially in thecase of death, Romero adds. An individual propertymay be difficult to assess for estate valuation purposes,and it may be difficult to recoup the property's fullappreciation. With a TIC, ownership value is usuallymore easily determined, liquidation more readilyaccomplished, and heirs have the option of takingover TIC ownership and utilizing a stepped-up taxbasis, which greatly reduces and sometimes eliminatescapital gains taxes.
If this opportunity sounds like a good idea, thereare a few things you need to know before you forgeahead. First consult with an experienced real estatebroker, who should ultimately be responsible foroverseeing the complex 1031 exchange. The due diligenceon the 1031 exchange is done by the real estateinvestment sponsor, who also arranges the financingon the properties, ideally using a security wrapper,which structures the private placement with full disclosureto protect investors.
A Good Fit?
The TIC 1031 exchange is not for investors whoprefer an active role in property management. Forthose physician-investors who do prefer more involvementand appreciate the advantages, however, Romerosuggests that they have their advisors investigate thecompany sponsoring the exchange and make sure theypurchased the property and arranged for financing inadvance. Sponsors who lack sufficient capital may flirtwith danger and try to "time" the purchase, which canleave investors high and dry.
is a freelance writer based in La
Quinta, Calif. He welcomes questions or comments
at 800-835-1700 or email@example.com.