Sheptoff
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1031 Exchange and the Tenant-in-Common Structure“No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.” - Section 1031 of the Code The large tax burden that often accompanies the sale of an investment property can be a troubling issue. Thankfully, this burden can be removed through an Exchange of real estate, effectively trading one investment property for another. The above quote is taken from Section 1031 of the Internal Revenue Service Code of 1986. The code offers a great solution for those needing to defer the capital gains tax that arises with the sale of real estate. A 1031 exchange is a transaction in which a taxpayer is allowed to sell one property and buy another without a tax consequence, usually through either a simultaneous exchange or a delayed exchange. This allows the exchanger to put all of the equity they acquired in the sale to work for them, rather than just a portion. Who is a 1031 Exchange for?Anyone who has investment property they would like to sell but wish to remain invested in real estate may wish to consider a 1031 exchange as an investment option. A 1031 exchange may be used to accomplish many investment goals of the exchanger. Clients who wish to defer their capital gains tax, diversify, or consolidate their real estate holdings, increase the leverage on their investment, or even relocate their investment to another market, can achieve this using a 1031 exchange. What is a Tenant-in-Common?When an exchanger wishes to complete a 1031 exchange, but does not want to exchange into another management intensive property, one option available is for the exchanger to invest in a portion of a professionally managed, commercial grade property along with several other investors. This is an investment structure called “Tenant in Common” or TIC. Tenant-in-Common is a form of holding title to real estate that allows investors to own an undivided interest in property, and thus, if structured properly, satisfying the 1031 requirement for “like-kind” property to be exchanged. TIC StructureThere are several aspects to the TIC structure that require a closer look: Special Purpose Entity (SPE)One thing that you will notice about the above ownership structure chart is that there are no individual investors listed as owners. This is because when a real estate owner exchanges into a TIC structured replacement property, they are often required to form a Special Purpose Entity (SPE), often in the form of a bankrupt remote single-member limited liability company, to purchase and own the TIC interest. This entity provides an extra layer of liability protection for the individual, the other co-owners and the lender. Tenant-in-Common AgreementTIC structured offerings are formed with an in-place TIC Agreement. This agreement describes the relationship between the investor and all of the other TIC owners. The rights and obligations of the Tenants-in-Common are governed by this agreement. In addition to the TIC Agreement, offerings are structured with an additional document signed by each TIC owner providing the sponsor with the ability to handle the day-to-day activities of the property. Thus the TICs have little required of them in the way of management. This ability is conferred in two ways: •Master Lease—a variety of Tenant-in-Common where the TICs act as the landlord, or Master Lessor, of the property, collecting rent from the tenant, or Master Lessee, who then subleases the individual suites to the tenants in the master lease. The sponsor typically oversees the management of the property (leasing, collecting rents, upkeep, etc.) TICs are paid a fixed rent according to the master lease, typically with possible annual increases. The Master Lessee typically keeps any property net income over the master lease rent amount.
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