Articles

The IRS has just issued a new ruling that sets forth the guidelines for those taxpayers that wish to do a 1031 exchange involving a vacation home. While I believe that the IRS intends that the ruling will put to bed all of the controversy surrounding this issue, it will certainly create more controversy than it settles.

By way of background, you can only exchange property held for investment or used in a trade or business. Personal use property, such as a residence, does not qualify for an exchange; so the question is: are vacation homes investment property or personal use property? Up until last year there was no guidance from the IRS that said that vacation homes do not qualify for an exchange, but that changed when the U.S. Tax Court disallowed a taxpayer’s exchange from one vacation home into another.

The big rage in real estate these days are TIC interests. TIC stands for "tenant-in-common," which is the legal title that these types of interests hold title to property. TIC interests are program investments similar to the partnership tax shelters of the 1970s and '80s, in that they pull together a group of investors to purchase one large property.

There are two major reasons for this great surge in these type of investments: the first is that the IRS approved TICs as suitable replacement properties for 1031 exchanges in 2002. Prior to that date it was uncertain whether a TIC interest could be purchased as the replacement for a 1031 exchange because their structure so closely resembles a partnership. As a result investors were wary of them. Today, however, approximately 70% of the TIC interests are purchased by such investors.

One of the critical requirements for a 1031 exchange is the same taxpayer must hold title to both the Old and New Properties in the exchange. While the exact amount of time these properties must be held is not defined by the IRS, it is clear that it has to be the same taxpayer, and both properties must be held for investment.

If Fred and Sue, for example, own an apartment building they are selling as joint tenants, and buy a replacement property for their exchange as joint tenants, then clearly the exchange involved the same taxpayers since Fred and Sue were on title for both the Old and New Properties. But what if Fred and Sue wish to protect themselves by putting the New Property into an LLC as soon as they acquire it? Most attorneys would say that was a smart business decision and quickly set up the LLC for them.

...if you have control over a transaction . . . the IRS could view your transaction as a violation...

The market for fractional ownership of commercial real estate (popularly known as Tenants-In-Common or TICs) is expanding its reach -- and look out!

These new ownership programs allow individuals, who normally may not have access to the institutional real estate market, to buy interests in large scale commercial real estate. In March, 2002, the IRS released Revenue Procedure 2002-22 which set forth the conditions and guidelines under which the IRS will allow a small group of single owners to invest into large real estate projects such as: office buildings, apartment complexes, shopping centers, even the neighborhood Wal-Mart store. But there are some inherent drawbacks, such as no established secondary market for selling your TIC interest, resulting in a less liquid investment.