Tenant In Common & 1031 Tax Deferred Exchanges
Helping investors understand TICs & 1031 Tax Deferred Exchanges
1031 Exchanges: Keep your real estate profits for investment in new properties
November 7th, 2006 by Troy
1031 Exchanges: Keep your real estate profits for investment in new properties
Original Publication: Monday, October 9th, 2006
Investors are turning in growing numbers to Section 1031, an 80-year-old-plus part of the Internal Revenue Code (IRC), to defer taxes on commercial real estate properties where prices have jumped in recent years. Rather than selling outright and getting hit with a large tax bill, they are instead trading into another property to defer the tax bite well into the future — perhaps indefinitely.
“A 1031 tax-deferred exchange is a powerful tax deferral strategy,” says Jeffrey Cederberg, from the New York office of CapWest Securities, Inc. “Taxpayers should never have to pay capital gains tax on the sale of investment property if they intend to reinvest the proceeds into similar or like-kind property.
“With the 1031 exchange, you defer three things: federal capital gains tax, state capital gains tax and depreciation recapture. If you ‘swap ‘til you drop,’ upon death your heirs will inherit the property at its market value — the capital gain is erased — so it is an effective estate-planning tool.”
Given the clear benefits of the 1031, it is gaining in popularity. “Our pipeline of 1031 requirements continues to be active as the sales market has continued to be vibrant,” says Kenneth L. Zakin, senior managing director of Newmark Knight Frank’s Capital Group in New York.
“The objective to defer gains taxes and to trade into replacement properties goes on unabated, and we have solidified our role as one of the most active providers of such advisory services in New York.”
Chad Brue, managing director of the private client group of CB Richard Ellis (CBRE) in New York, concurs. “Activity from 1031 exchange buyers remains very strong throughout the country, and is elevating commercial property values to new highs due tothe aggressiveness of this buyer type,” he explains. “CBRE’s unique access to 1031 exchange buyers through our proprietary database ensures that the sellers we represent will achieve top dollar for their property.”
The Qualified Intermediary
IRS rules for 1031s are exacting. “The taxpayer cannot receive or constructively receive any of the proceeds from the sale of the relinquished property; otherwise the proceeds are taxable as ‘boot’,” according to Marie Flavin, Northeast regional manager, IPX 1031, in Armonk, N.Y. “Boot” is any non-like-kind property received in a 1031 exchange. Therefore, the taxpayer will require the services of a Qualified Intermediary or QI: a third party, unrelated to the taxpayer, who participates in the 1031 exchange and holds the money from the sale of the property in escrow.
To find a QI, Dennis P. Helmick, president, Exchange Facilitator Corporation in Seattle, Wash. and president of a trade association of QIs, the Federation of Exchange Accommodators (FEA) in Philadelphia, Pa., suggests clicking on the association’s web site at www.1031.org, which lists hundreds of QIs around the country.
Margo Mucha McDonnell, president and CEO. of the 1031 Corporation in Royersford, Pa., co-chaired an FEA committee that helped create a nationwide qualification program to certify QIs. “Many people do not realize that our industry is unregulated. You need to look at the company’s credentials. One way to choose a QI is to ensure that there is a Certified Exchange Specialist® or CES® on staff.”
People who have been growing their retirement nest egg by investing in and renting out real estate need the absolute correct information regarding 1031 exchanges. A highly experienced QI can be invaluable in this role, stated Bettye Matthews, president, Exchange Professionals in Westminster, Md.
“The taxpayer should choose the exchange accommodator carefully,” warns Lori DeMartini, president, OREXCO, of Oakland, Calif. “There have been many cases of embezzlement and bankruptcies among exchange accommodators. There are hundreds and hundreds to choose from. Make sure the exchange accommodator is reputable, bonded and insured.”
Selecting a Replacement Property
A critical step to successfully completing a 1031 is to find a suitable replacement property. Many helpful resources can assist in this. For example, Alan Fruitman, president, www.1031tax.com in Denver, Colo., manages a database of single-tenant, triple-net-lease properties and shopping centers for those undertaking 1031s. The list is constantly updated by 25,000 brokers, sellers and developers from around the United States.
Time is of the essence in 1031s: from the time the initial property is relinquished, a new one must be identified within 45 days and the deal closed within 180 days. In a real estate1031, as long as the replacement property is used in business or held for investment, raw land can be replaced with a shopping center or a warehouse with apartments. Another replacement option is a single-tenant, triplenet-lease property. The great benefit of a triple-net-lease or simply net-lease property is that the tenant is obligated to pay all expenses of the property being leased as well as the rent.
While triple-net-lease property is a highly desirable 1031 replacement choice, not everyone can afford the price tag. For the smaller investor, a tenant-in-common (TIC) property could be a good alternative. Ryan Bristol, CEO of PropPoint in Santa Monica, Calif., is a consultant to the 1031 market. He points out that with the TIC, a taxpayer can exchange a property for fractional ownership in an investment-grade property owned with other 1031 investors. Dan L. Werry, managing director 1031 & TIC Investments of Minneapolis, Minn., agrees: “If an individual sells a property for between $300,000 and $600,000, we would typically recommend a tenant-in-common ownership. The reason is that they have an opportunity to buy into high-quality, institutional-grade real estate that they would normally not be able to. The credit quality of these tenants can be very high.”
Naturally, before exchanging one property for another, investors must not only research the new property but also those with whom they would do business — particularly if theyare investing in a TIC. Richard Kaplan, president, Syndicated Equities, Chicago, Ill., said that investors must find someone they can trust — and feel comfortable working with. “The most important research is the track record of the sponsor. One place where people get hung up is that they pick a TIC sponsor, they identify one of its properties to trade into, and then the TIC sponsor does not consummate the transaction. We are proud to say that we have never had a person not complete a trade because we did not close on a property.”
Another option, suggests Peter J. Behr, vice president of investment property sales, Trustreet Properties, a real estate investment trust (REIT) located in Orlando, Fla., is to look into the benefits of investing in restaurant properties. “We are the single largest REIT focused on the restaurant sector in the United States, with over $2.5 billion in assets. We have over 2,000 restaurant properties in our portfolio — including over 170 concepts and 500 tenants in 49 states.
This advertising supplement is sponsored by participating advertisers. The material was prepared by Ron Derven and did not involve the reporting or editing staff of The New York Times.
Source: New York Times
Publication Date: 10/02/2006