Popular Tax-Savings Strategy for Property Owners
Posted on 05.21.15
By: Lauren Barton, CPA, Supervisor | Real Estate & Construction Industry Team
Alternative 1031 Like-Kind Exchange Strategy
With both property values and tax rates at their highest levels in several years, selling a property can be a double edged sword for many taxpayers. A 1031 like-kind exchange has been a popular tax-savings and deferral strategy that has picked up popularity as the market is on a rebound. Sometimes finding a specific replacement property that is appropriate for your business needs or portfolio, while still considering the exclusions involved, can be very difficult. One option that has been gaining momentum recently is a Tenant in Common arrangement. This is also known as a “TIC.”
A tenant in common is a shared ownership of property. It contains multiple percentages of ownership interest that can vary in size. Each share is undivided, so no co-tenant has exclusive right. Also, no co-tenant has right of survivorship, so this can also be used as an estate planning tool as well. Your ownership can be passed down to heirs or your estate. The TIC’s typically own several properties within one portfolio; they can range from residential complexes, commercial offices and medical buildings, and strip-malls and shopping centers.
In 2002, the IRS released Revenue Procedure 2002-22, which stated that undivided fractional interests in real properties that are held by TIC’s did NOT constitute an interest in a business entity. The procedure simply states that a taxpayer may exchange their wholly-owned real property for a TIC interest. As you may already be aware, the 1031 exchange rules to do not allow property to be exchanged for interests in other business entities.
Below is a brief summary of the conditions set forth by the IRS (Revenue Procedure 2002-22, Section 6) for exchanging real property for a TIC interest:
- Each of the co-owners must hold title to the Property as a tenant in common under local law.
- The number of co-owners must be limited to no more than 35 persons.
- The co-ownership may not file a partnership or corporate tax return, conduct business under a common name, execute an agreement identifying any or all of the co-owners as partners, shareholders, or members of a business entity, or otherwise hold itself out as a partnership or other form of business entity.
- The co-owners may enter into a limited co-ownership agreement that may run with the land.
- The co-owners must retain the right to approve the hiring of any manager, the sale or other disposition of the Property, any leases of a portion or all of the Property, or the creation or modification of a blanket lien. Voting must be unanimous.
- In general, each co-owner must have the rights to transfer, partition, and encumber the co-owner's undivided interest in the Property without the agreement or approval of any person.
- If the Property is sold, any debt secured by a blanket lien must be satisfied and the remaining sales proceeds must be distributed to the co-owners.
- Each co-owner must share in all revenues generated by the Property and all costs associated with the Property in proportion to the co-owner's undivided interest in the Property.
- The co-owners must share in any indebtedness secured by a blanket lien in proportion to their undivided interests.
- A co-owner may issue an option to purchase the co-owner's undivided interest (call option), provided that the exercise price for the call option reflects the fair market value of the Property determined as of the time the option is exercised.
- The co-owners' activities must be limited to those customarily performed in connection with the maintenance and repair of rental real property (customary activities).
- The co-owners may enter into management or brokerage agreements, which must be renewable no less frequently than annually, with an agent, who may be the sponsor or a co-owner (or any person related to the sponsor or a co-owner), but who may not be a lessee.
This structure can open many doors for taxpayers who may not otherwise have the means of access to some higher dollar, expensive properties, or are unable to find other properties to complete a proper 1031 exchange.
For more information on this tax deferral strategy, or if you have any other questions on a 1031 Like-Kind Exchange, please consult your opportunity advisor at Keiter or firstname.lastname@example.org | 804.747.0000
Lauren is a Tax Supervisor at Keiter. Her client base consists of real estate development, construction, retail, and service-based firms. As a member of Keiter's Real Estate & Construction Industry team, Lauren stays informed of tax changes and tax savings opportunities and shares her industry insights with her clients. Read more of Lauren's articles on our blog.