1031 and TIC: How They Work Together to Provide a Hassle-Free Income Stream

 

The real estate boom may or may not be over depending on the part of the country you live in, but I still encounter a lot of people looking to sell investment property. Usually, the people I deal with aren’t looking to flip that fixer-upper they picked up before the boom hit. I tend to work with professionals who are holding a small piece of commercial real estate like a little office park or rental property like a small apartment complex. Generally, these people are at a point in their lives where they are winding down income producing activities and perhaps going into retirement or semi-retirement. Given this, they usually need or want the income stream their investment property generates, but they don’t want the hassles of property management anymore. Structuring the sale of that property through a 1031-tenant-in-common deal can take care of both of those needs and provide a nice tax savings to boot.

Since I usually do this with doctors and lawyers retiring from practice, lets walk through an example of how such a deal might work with the hypothetical Danielle Doctor. Let’s say she practices medicine in Houston, Texas – a great college town – where she also owns a parcel of land with eight little cottages on it that she rents out to university students.  For the past 15 years, besides busily working at her thriving medical practice, she has hired landscapers and pest control professionals to take care of her property. She has let locked-out freshman into their homes at 2AM, and re-keyed doors when keys were completely lost. She has chased down late rent and cleaned up trashed kitchens at the ends of school years. She has unclogged toilets, re-tiled floors, painted eaves, and she’s tired of it. She doesn’t want to manage property anymore even though she likes the extra income. She wants to remain in control of her asset, but doesn’t want to have to baby-sit it.

Once Danielle Doctor decides to sell her apartment complex, she’s probably thinking of a 1031 exchange already since many people are familiar with the tax benefits of such a “sale”, but doesn’t see how that would relieve her of property management troubles. This is where the tenancy-in-common comes in. It works like this. The land is sold, but as a 1031 exchange, not a straight sale. Danielle chooses a TIC property for the exchange. After the sale of her own property, but before the close of escrow, she finds a qualified intermediary and lets him know she wants to do a 1031 exchange. The intermediary exchanges the money from the sale for the new TIC property – there are usually no closing costs – and when it’s all said and done, Danielle Doctor owns a fractional interest in a new piece of real estate. She didn’t pay any capital gains or recaptured depreciation, and won’t as long as she continues to sell the property through the 1031-TIC structure. Since Danielle still controls the asset, if she’s holding it at her death, the estate will owe taxes, but it will pass to her heirs at a stepped up fair market basis, meaning they won’t pay any capital gains tax either, if they sell it for the date of death value.

Besides not having to manage property anymore, the chief advantage of structuring a real estate sale this way is that Danielle Doctor is able to leverage her money by pooling it with other investors. This way she is able to buy more valuable property for a relatively small amount of money. More valuable property means a larger stream of income since the annual income flow on investment property is usually about 5.5 to 6% of equity.

You may wonder why, when Danielle exchanges one piece of property for another in a 1031-TIC deal, she doesn’t have to manage property any more. After all, she does still own land. Isn’t she still just a landlord? Technically, yes. When you do a 1031-TIC deal, you are still a landlord. However, tenancy-in-common is a form of joint real estate ownership; there can be up to 35 co-owners. Basically, now Danielle is just one of many landlords, perhaps part of a consortium that invests in real estate. A professional management company takes care of all the usual landlord tasks and often covers insurance costs, property taxes, vacancy issues and day-to-day management expenses.

Paula Straub
Save Gains Tax


This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are meant for informational use only. The information contained on this site does not constitute advice on tax or legal issues. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

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