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
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intended as an offer or solicitation for the purchase or sale of any
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instruments or strategies mentioned herein may not be suitable for
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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.
