When it comes to investing in a 1031 Exchange Tenants in Common, an informed choice can make all the difference. Getting the basics right can save you a lot of money, taxes, and even maintenance responsibilities.
Often used for tax purposes, 1031 Exchanges are beneficial for a mortgage and in heirship too. But is it worth it to invest your hard earned money in a Tenants in Common ownership? How can you form a TIC 1031 Exchange with co-owners of the investment property? What about the rules that you have to follow for a property swap?
Before we answer these questions, it would be beneficial to clear any doubts about what a Tenant in Common 1031 Exchange means.
Significance of 1031 Exchange Tenants in common (TIC)
If you and a partner decide to invest in property together, you can hold ownership as a Tenant in Common. Each owner will have a stake in the property, which may not necessarily be equal.
The 1031 Exchange aspect comes into play when we consider the taxes and reinvestment aspect of real estate. The United States Internal Revenue Code specifies Section 1031, which can be helpful to defer capital gains, Alternative Minimum Tax, and depreciation recapture on an investment property.
Two or more investors can share ownership of the properties they purchase using a 1031 Exchange TIC. It can aid in building wealth, diversifying the investment portfolio, and reducing the maintenance incurred on a property.
If you are planning to invest in a luxurious property or multiple high-quality properties with many owners, 1031 Exchange TIC can be the route. It can help you diversify your holdings and reduce the costs incurred if you had bought the properties all by yourself.
In 1031 Exchange TIC, investors pool funds to buy a joint property. Proportionate to their share, they participate in tax shelters, income, and the growth of that property. While each investor gets a separate property deed, they can isolate or transfer ownership without consent from co-owners.
Diversification is also conceivable as Tenants in Common 1031 Exchange can invest in a hospital, hotel, office complex, warehouse, storage units, or an apartment to elevate one’s investment portfolio.
So, while an individual may be unable to buy a property worth millions, Tenants in Common 1031 Exchange will let many people or business entities invest in it.
When selling this property, the proceeds can go to invest in a similar property. 1031 Exchange lets the investor avoid some or all of their capital gains tax by allowing reinvestment of profits from one property to another.
Each property owner in TIC ownership can withdraw their fractional stake in the property, mortgage it without requiring the consent of co-owners, or sell their share. In case of a property holder’s demise, the ownership interest passes down to their heirs. Other owners cannot claim that share. This feature sets TIC 1031 Exchange apart from others.
Many real estate investors use 1031 TIC investments to grow their businesses. All made possible by rolling gains from one real estate into another like-kind property. They pay capital gains tax when they sell their final investment for cash.
Another reason why people invest in TIC 1031 properties is that the risk spreads across multiple stakeholders. If the property fails to increase in value or incurs any damage, co-owners share the costs themselves. This load-sharing eases the burden on an individual.
All owners generally enjoy equal rights and benefits of the property. They can agree to limit access to specified areas or designate exclusive rights to the income generated from those assigned spaces.
Delaware Statutory Trust (DST) and TIC
Fractional ownership is also possible under a Delaware Statutory Trust (DST). Despite being similar to Tenancy in Common, DST and TIC are different structurally.
A DST represents a passive investment on which the Delaware statutory law defers the capital gains tax payments. The trust’s sponsoring firm manages the investment properties and is in charge of their acquisition.
However, a Tenant in Common 1031 Exchange represents joint ownership between multiple partners. All the aspects, including costs and profits, are shared proportionately among the partners.
Many investors take the TIC route because, due to its nature, they view TIC ownership as a single asset. Thus, it is subject to a single round of tax payments. The undivided interest of each owner and the ability to sell individual shares excites investments into a TIC.
A crucial question to answer is if you can live in a 1031 TIC Exchange property.
This isn’t permitted in a 1031 TIC Exchange. You can only utilize a 1031 TIC Exchange for investment or property meant for business use. 1031 Exchange does not accept personal-use real estate as like-kind.
An exception to this rule will be your previous homes and vacation homes. An earlier home can later qualify for a 1031 Exchange if you rent it out for a few years. If your vacation home is rented and not used by you for 10% of the total rental time or more than 14 days, it will also become eligible for a 1031 Exchange.
Is it worth going for 1031 Exchange Tenants in Common Investments in Property?
1031 Exchange Tenants in Common Investments offer a fantastic opportunity for financial gain. By joining other investors, you can own an otherwise unaffordable real estate investment property. For example, many investors may not have purchased an apartment valued at $10 million, but 20 co-owners can pool in $500,000 each on an average and invest in that apartment. A 1031 Exchange TIC permits that.
Since minimum investment on a TIC property reduces significantly, individuals can acquire multiple properties through this investment strategy. Investors can therefore diversify their portfolios and make investments safer. The effect of experiencing a loss lessens, and you can reinvest gains elsewhere.
But real estate demands real maintenance. You have to look after the upkeep and manage the property. For this, you can rely on others as everyone pulls their weight but has to do lesser work than if they had owned the property single-handedly. Routine duties such as leasing, mortgage servicing, and rent collection are off your back.
Quick and easy on the pocket
In a 1031 Exchange Tenant in Common investment, the closing costs and those associated with deed recordation reduce significantly. What’s more, with no negotiation and credit checks involved, you can expect a TIC Exchange to be through in a few weeks. Quick process and reduced costs? Yes, please.
That said, there are a few factors that you must keep in mind before signing up for a Tenancy in Common 1031 Exchange.
While you are sharing the risks involved with co-owners, you will have to share the rewards too. If you were a sole investor, you would have got a hundred per cent of the rent or sale proceeds. But in a TIC, the income you generate is shared with other investors proportionately.
This brings us to decision-making. Being a sole owner gives you the right to decide on every aspect of the property. However, having co-owners means that you will have to vote when you make decisions. If a group vote for vital decisions sounds like a no-no for you, rethink the TIC 1031 Exchange. According to IRS Revenue Ruling 2002-22, it is required to conduct a group vote before moving forward.
Now let’s talk about what happens in case of a default. If one of the Tenant in Common 1031 Exchange investors fails to pay the mortgage payments, other borrowers ensure they make those payments to avoid foreclosure. Else, the holdings may be seized from all the investors. To avoid this, investors can opt for a Single Member Limited Liability Company ownership for liability protections.
Access and buyers
Depending on the Agreement that you sign, you may be required to limit your access to certain areas of the property. And if you are planning to bring in the best buyer you could find, pause because a proposed buyer has to be approved by the co-owners. Does this mean that you might have to lose a buyer? Sometimes, yes.
Yet another influence on your TIC 1031 property will be the liquidity of that investment. If you want to invest money for liquidation, a TIC asset may not be the best way to go. There are restrictions on transfers, which make TIC properties not the most liquid investments.
For managing your property, you will also need a TIC manager. The costs incurred on that could be significant, and you may also have to understand that the manager will exercise pronounced control over the investment. As a co-owner, you may not be involved in the routine activities that the manager conducts.
So is it worth going for Tenants in Common 1031 Exchange?
You and your circumstances best answer that question.
It may have been easy to pool funds in college for upgrades in your dorm room. But investing money with partners in real estate must be considered from all viewpoints.
The rewards are fair, square, and proportionate, and the risks are shared. You save on the capital gains tax, and maintenance work is shared. You can diversify your investment portfolio and invest in properties that you may not have been able to buy as the sole investor. But sharing responsibilities, duties, costs, and access are the factors you must consider before becoming a Tenant in Common 1031 Exchange.
If you decide to take the plunge and grow your investments, you must know how a 1031 Exchange TIC forms. What are the rules involved in it? Let’s find out.
Strategic Procedures to form a 1031 Exchange TIC
Now that you know about 1031 Exchanges, you are ready to form a TIC Exchange and start swapping properties!
You and your fellow investors can start by preparing a TIC Agreement to delegate all parties’ responsibilities and rights and define the conflict resolution methods. A sponsor may partake in this if retained by the investors. Sponsors help with the complexities and employ standardized terms for all the participants.
A Tenants in Common Agreement contains the Revenue Procedure 2002-22 guidelines. The Agreement talks about investors’ right to transfer investment interest or share costs and proceeds proportionate to their ownership. Maintenance duties, as well as property access for own and common areas, are also detailed.
The Agreement provides directions on allocating shared costs like taxes, utilities, insurance, and loans in the TIC Agreement. What happens when there is a potential buyer? Can the co-investors refuse? The TIC Agreement has all the answers.
Owner interest in property title
A 1031 Exchange Tenants in Common forms effectively when investors designate each owner’s interest after taking a property title. The common law and state statutes will dictate the TIC model if an agreement is absent.
With an Agreement in place, you are ready to find an investment property and add it to your portfolio. The investor group can settle on each owner’s fractional ownership.
For instance, if you and other investors buy an apartment complex, TIC interests can be sold, and access rights to single units can be assigned. The Agreement will chalk out the further details.
After a property is acquired, joint management duties are assumed by investors unless the Agreement outsources it. Over time, new owners can join per the details in the TIC Agreement.
When the investors find a potential buyer and want to relinquish that property, they have 45 days for nominating a possible replacement and 180 days from closing to acquire it.
Following this, investors can work with an attorney to carry out the 1031 Exchange. With a written exchange agreement, a qualified intermediary can help transfer the relinquished property to the buyer and acquire and transfer the deed to the replacement property from the seller. The properties exchanged must be located in the United States. While trading property across state borders is usual, you should be aware of the tax policy in that state.
Exchanging TIC for like-kind holdings
Is it possible to exchange your TIC interest for a different property? The 1031 Exchange rules specify that you can include your Tenant in Common interest in one property in a separate 1031 TIC Exchange or a like-kind property, which may not be a TIC but qualifies for a 1031 Exchange.
For instance, if you have stakes in a hotel and plan to exchange it for portions of a restaurant, you can do so with a 1031 Exchange. Are you thinking of exchanging an office complex for apartment buildings or a shopping center? Go ahead and do it because 1031 Exchange allows that.
Dissolving the TIC
The TIC can dissolve when one or more co-investors decide to buy shares of the other members. A joint TIC Agreement is required if co-owners differ on how the property should be used, improved, or sold. In case of its absence, the property can be partitioned voluntarily or by a court order.
A common misconception among investors is that they need to reinvest the entire sales amount, or more than that, into a new property. But what if you want to invest in a property that has a lower price?
In 1031 Exchange Tenancy in Common, you can reinvest the net proceeds in a property with a lower value. The amount left with you after investing is liable for taxation. This implies that you are free to sell a property at $200,000 and use $150,000 for reinvestment. The remaining $50,000 will be taxed.
Compliance Rules for 1031 Exchange TIC Property
With a TIC Agreement, group of investors, property, and procedures in place, let’s turn to the IRS Revenue Ruling 2002-22 for rules that you must follow as a Tenant in Common 1031 Exchange:
Number of investors
The IRS Revenue Ruling states that a TIC property can have a maximum of 35 investors. If you plan to join a TIC or bring a new member on board, ensure beforehand that the number of co-owners in that Tenancy in Common is less than 35.
Joint tax returns
As a co-owner, you share the maintenance and proceeds. However, filing a partnership or corporate tax returns or conducting business under a common name is not permitted. You and your co-investors will thus have to pay your taxes.
Being a co-owner in a Tenant in Common 1031 Exchange means that investors will make all the decisions related to the investment property through voting. The Tenants in Common vote and approve over managerial aspects and retain transfer rights, partition, or limited interest in the property.
The Revenue Ruling 2002-22 requires that all owners must hold TIC title per the local law. So, for a group of 10 investors, each one would be a TIC titleholder.
Reinvestment from the first sale
In a Tenants in Common 1031 Exchange, you have to reinvest 100% of the first sale’s proceeds. The replacement property, in this case, needs to be valued equal to or greater than the relinquished property.
Co-investors must share income, expenses, debt, and other costs incurred on the property proportionate to their ownership.
Co-owners are required to satisfy the debt before selling properties and distributing proceeds.
Loan from TIC
An investor cannot obtain loans from a co-owner of the property in which they have entered a TIC 1031 Exchange.
Whether managerial or brokerage, co-investors must renew the TIC Agreement annually to consider any changes that the owners may want.
Buying interest in the property
If a co-investor in a TIC wants to purchase an interest in the property, they can do so. The price for this purchase must reflect the market value for the property relinquished.
The payments made to the sponsor for the 1031 Exchange should be following the fair market value of the sponsor’s services.
All leases in a 1031 exchange TIC must be bona fide for federal taxation. The rent that a lessee pays should reflect the fair market price for using the property. The rent should be independent of the income or the profits derived from the leased property.
Activities of co-owners
Co-owners must limit their activities to those performed customarily for the maintenance and repair of the rental property.
Autonomy on own share
Unless stated otherwise in the TIC Agreement, every co-owner has the right to transfer, partition, and sell its TIC interest in the property without requiring approval from other co-owners.
Let NNN Deal Finder Be Your 1031 Exchange Expert Guide
1031 Exchange Tenants in Common can be a rewarding investment strategy and help you build wealth. With co-owners, costs and risks get shared, giving you a safety net to diversify your portfolio. The compliance rules and terms and conditions can seem daunting, but they do not have to be.
Put an end to the confusion as Dwaine guides you on how you can build a strong investment with returns that are predictable and profitable. At NNN Deal Finder, he offers professional guidance and personalized advice tailored for you to reap the benefits of 1031 TIC Exchange. A professional who has helped hundreds like you, Dwaine can make the complex compliance rules simpler and help you become a more confident, informed, and successful investor.
It’s time to let the right investment find you. Request your list of NNN properties from Dwaine and get a customized list of NNN Properties for sale directly in your inbox.
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Any property maintained for active use in a trade or commerce, as well as for investing, can be traded for a similar property. The term "like-kind" refers to the investment's essence rather than its form. Any sort of investment property can be traded for another type.
A 1031 Exchange applies to property held for productive use in commerce or company or investment. Even if the property is employed in commerce or company or for investment, the tax legislation explicitly excludes certain types of property. Stocks, bonds, notes, securities, and partnership interests are among the things that are excluded.
Calling your Exchange Facilitator is all it takes to get started with an exchange. It would be beneficial for you to know information on the parties involved in the transaction before making the call (for example, names, addresses, phone numbers, file numbers, and so on). The exchange coordinator will ask questions regarding the property being ceded and any suggested replacement property during the phone call.
Contact an exchange facilitation business in advance of your exchange. Facilitators' identities can be found on the internet, through attorneys, CPAs, escrow businesses, or real estate brokers. Facilitators should not behave as "agents" in addition to being facilitators. Escrow firms, attorneys, real estate agents, and other agents are not facilitators and should not be employed. Inquire about the methods used and the support they may give in the event of an issue.
Although there is no set period of time in which you must own a property before altering its use, the IRS will consider your intentions. You must have purchased the property with the aim of holding it as an investment. This may include, but is not limited to, renting the house at market price. It is recommended to season the home as an investment for at least one year before moving in, as the government has recommended a one-year hold period on two occasions. The year-end gap between short- and long-term capital gains tax rates is another factor to consider when considering hold durations.
It makes no difference how many properties you exchange in or out of (1 property into 5, or 3 homes into 2) as long as the worth, mortgage, and equity move up or down. The main issue with exchanging into more than three properties is staying within section 1031's time and classification constraints.