Beware of Tenant-In-Common Schemes with 1031 Exchanges

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.


1031 Reverse Exchanges: How exactly do they work

Up until the IRS approved Reverse 1031 Exchanges in a ruling (Rev. Procedure 2000-37) issued in September, 2000, many people, especially tax professionals, were skeptical of them. Now, however, even though there is lots of talk about them, many people really don't know exactly what a Reverse Exchange is and how it works.

Reverse Exchanges arise when you want to (or need to) buy your New Property before you've sold your Old Property. The problem is that the IRS will not let you be in title to both your Old Property and your New Property at the same time. This situation, then, gives rise to a Reverse Exchange.


Refinancing 1031 Property in an Exchange

To refinance or not to refinance: this is the common question many 1031 exchangers ask. By refinancing, exchangers are usually hoping to pull money (cash) out of their sale transaction to use for purposes other than investing in new 1031 property.

To answer the question, we need to understand the timing of the refinance. Based on the whether you, the taxpayer, are pulling money from the old, relinquished property or from the new, replacement property, the IRS has varying positions.

When refinancing the old property, a key 1031 exchange requirement drives the IRS’ position. The taxpayer cannot receive, touch or control the funds generated from the sale of the old property during the period until the purchase of the new property. Does refinancing the old property right before the exchange constitute “receiving money”?


Clearing Up Confusion: 1031 exchanges can provide significant savings on capital gains

Saving tax money can be a complicated process. Although confusing, understanding IRS Code Section 1031 is worth it! 1031 exchanges can provide significant savings on capital gain taxes.

An exchange connects the sale of an old property and the purchase of a new property to postpone taxes. Exchanges are great for investors who are selling investment property that has increased in value or has been depreciated for tax purposes. Unfortunately, legal and tax experts are oftentimes confused about these IRS rules. Much of the confusion comes from the relief (payoff) and replacement of mortgage debt on exchange properties.

The common misunderstanding about debt is that the investor must replace 100% of the debt held in the old property by taking on an equal amount of debt against the new property. This is incorrect. The solution lies in a thorough understanding of two tax themes addressed in The Code — taxable cash and taxable debt relief.


Exchange Place

Peter McCrea had a client who wanted to sell a piece of undeveloped land in order to invest in a new hedge fund. It was obvious to both McCrea and his client that selling a $5milliion chunk of property with virtually no cost basis would result in a hefty tax bill. So McCrea—an advisor with, a subsidiary of LHO Group in New Canaan, Conn.—suggested instead that his client exchange the property for an income-earning interest in it that could be mortgaged after closing. McCrea's strategy allowed the client to liquidate and reinvest 100 percent of his equity without incurring taxes, retain a real estate allocation with the potential for appreciation, and invest in the hedge fund—thus achieving his main objective.


Bankruptcy remote entities and 1031 exchanges

You've just sold your old property in a 1031 exchange for $500,000. You've found the perfect new property, and it's a steal at $2 million. Your exchange intermediary is holding $500,000 for you, and your banker is very receptive to your loan request for the balance of $1.5million. He giving you a break on the loan fee, and the interest rate is better than you hoped to get. There are no structural problems, and a few minor cosmetic changes should allow you to raise the rent a little, giving you a very respectable cash flow. Life is great — until the call…

At first it didn't seem that big a deal; the loan committee approved the loan, but requires that the property be held in what they are calling a bankruptcy remote entity. They want the property held in a separate entity, all by itself. That didn't seem unreasonable, so you called your attorney and hand him set up a corporation to own the property so that you would be protected from liability as well.


Using 1031s to transfer wealth tax-free

A 1031 exchange is a technique that investors commonly use to transfer property tax-free. However, our sophisticated investors are using 1031 exchanges to transfer large amounts of wealth, tax-free to their children.

This is how it works:

Mom and Dad own a building that is worth $100,000 and is free and clear. Finding a new building worth $150,000 the sell their old building and use a 1031 exchange to buy an undivided two-thirds interest in the new building for cash. Their children buy the other undivided one-third interest.

A year or two later they sell the building for $250,000 of which $166,667 is the parents’ two-thirds share with the balance of $83,333 belonging to the children. Both the parents and the children do 1031 exchanges and buy a new property for $400,000 of which $166,667 (or 42 percent) is the parents, and the balance of $233,333 (or 58 percent) belongs to the children.


IRS tightens related - party rules

A recent Internal Revenue Service ruling will now reduce taxpayer flexibility when they complete a 1031 exchange by buying property.