The Secrets of IRS 1031
The 1031 tax-deferred exchanges that occur for fractional ownership interests, or tenancy in common interests, have a complicated name, but are in fact much simpler than you may think. Earlier this year, the 1031 Revenues Procedures addressed the topic of tenancy in common interest as replacement property in 1031 tax deferred exchanges.
There are many advantages to using tenancy in common interests in order to complete a 1031 exchanges. You can make the interests easier to find suitable replacement property within a 45 day period, allow investors with limited amounts of money to spend to diversify their properties, and to give someone a chance to own a share of property that might otherwise have been too expensive for a single person.
Under the 1031 section, an investor in real estate gain defer gain on a sale by exchanging the gain for a similar property and also meet the specific number of requirements that go along with this exchange. To receive your tax deferral from this exchange, you will need to find a replacement property that is equal or greater to the net sale price of the property that is being sold. All of the proceeds from the sale must be used in the exchange.
If you are participating in one of these exchanges, you must also be able to find replacement property that is suitable within 45 days of the property sale. The title to the property must be taken by the investor in the same manner that he or she gives the title in the sale of the property. The reason for the title requirement is to prevent investors from buying into more attractive or larger properties when they have to buy additional shares or other interests of partnership to complete the sale.
Before this ruling on section 1031, many tax professionals were questioning the fractional interests as replacement properties because it could be seen by the IRS as the investor being interested in a partnership rather than the property. If it was seen as a partnership instead of a property exchange, the exchange would no longer be valid.
Now there are many companies within a niche community that are beginning to make use of TIC interests to have a complete 1031 exchange. All the investors want is a deed for a percentage interest in the property rather than a share of partnership in the owning of the property.
The minimum standards that need to be met for a TIC interest to qualify as a replacement property in the exchange are: the number of tenants in common must be under 35, the sponsor cannot own the property for more than six months before all of the interests are sold, any decision that will have economic impact on the property must be voted on and approved by all owners, the management agreements must be renewable, and the management agreements must also provide for market rate compensation.
1031 exchanges are still a new type of property investment, but as the trend catches on there will be more and more opportunity to invest in this type of venture.