What Is a 1031 Exchange?
|Let’s continue the discussion on 1031 exchanges, with a focus on the final two kinds of exchanges: Reverse Exchange and then we’ll explore a TIC (Tenant in Common). A TIC can be used as a replacement property option in a 1031 exchange, which will carry NO management issues.
Reverse Exchange: This is the most complex type of exchange. This exchange permits the investor to acquire the replacement property before the relinquished property is sold. Under no circumstance may an investor be on title to both properties simultaneously. In September 2000, the IRS indicated that a reverse exchange would be permitted if the transaction fell within the scope of the “safe harbor” provisions.
There are two options:
Option A – park replacement property – this means exchange last. Under this scenario, title to the replacement property is transferred to the EAT (Exchange Accommodation Titleholder) and not to the investor at the closing. The closing date then triggers the 45-day period to identify the property to be relinquished as well as the exchange period to sell the identified relinquished property. Once the escrow on the relinquished property is ready to close, the EAT enters into a simultaneous exchange with the investor to transfer the title of the parked replacement property to the investor upon the transfer of the relinquished property to a third-party buyer.
Option B – park relinquished property – this means exchange first. This scenario more commonly occurs when financing is obtained for the acquisition of the replacement property. Prior to the close of the replacement property, the relinquished property must be transferred to EAT. The transfer to the EAT triggers the 45-day period to identify the property to be relinquished and the exchange period during which the identified relinquished property will be sold.
Accordingly, this transfer ideally takes place shortly before the closing of the replacement property.
Issues to Consider: Any funds brought in for the acquisition of the replacement property by the investor may be reimbursed to the investor from the proceeds of the relinquished property and are not subject to capital gains tax. Any remaining proceeds can be utilized to reduce any debt previously incurred for the acquisition of the replacement property.
Free WorkshopI hope you can see the huge tax advantage to a 1031 exchange. It can also be daunting. Purchasing either more properties or a bigger property can add to management issues and may not be the desire of the investor. A TIC (Tenant in Common), can provide the investor the opportunity to go bigger and use those deferred taxes without more management responsibility. Part of my personal strategy is to exchange my rentals into TIC’s.
A TIC is a vehicle where an investor is permitted to pool their assets with other investors in the acquisition of like-kind replacement property. TIC’s are organized by syndicators to be essentially passive investment and repositories for proceeds of 1031 exchanges.
Under this co-ownership structure, the investor will own an undivided fractional interest in an entire property and share in a portion of the net income, tax shelters and growth. The Investor receives a separate deed and title insurance for the investor’s percentage of ownership in the property.
Cash flow is generally paid monthly and is tax-sheltered via depreciation pass through and interest deductions. The investor will also share in the appreciation of the property when sold. So an investor in a TIC has all the benefits of real estate ownership without any of the headaches or management.
An investor can get into a TIC with a minimum equity requirement as low as $100,000, which will allow the investor to invest in a high quality, institutional grade property. A TIC also allows the investor to be in a diversity of properties and locations.
Taxes are part of our reality, they shouldn’t be why we make decisions but they should always be part of the decision making process.
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