Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment. A tax-deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of "like-kind", while deferring the payment of federal income taxes and some state taxes on the transaction.

The theory behind IRS Section 1031 is that when a property owner has reinvested the sale proceeds into another property, the economic gain has not been realized in a way that generates funds to pay any tax. In other words, the taxpayer's investment is still the same, only the form has changed (e.g. vacant land exchanged for apartment building). Therefore, it would be unfair to force the taxpayer to pay tax on a "paper" gain.

 Exchangers can create an entire investment program using the wide variety of benefits available, and an investor can move successively from one 1031 Exchange to another any number of times while delaying the taxable event.  Two of the most popular strategies involve delayed exchanges combined with TIC properties.

Starker 'Delayed Exchanges'

Starker exchanges have for years been popular among realty investors and business property owners. A recent Starker development is a "reverse exchange," allowing a qualifying replacement property to be acquired before the currently owned property is sold. The IRS Code basically says a seller of a qualified "like kind" property held for investment or use in a trade or business can defer paying his/her capital gain tax by identifying, within 45 days after the sale of the old property, a qualifying replacement exchange "like kind" property to be acquired, and within 180 days after the sale of the old property, completing the acquisition of the identified replacement property.

However, if the exchanger takes out any "boot," such as cash or net mortgage relief, that "unlike kind" property received becomes taxable (the entire exchange is not disqualified, just the cash or net mortgage relief portion becomes taxable). But cash used to pay expenses, such as real estate commissions and fees for the third-party intermediary, is not considered taxable "boot."

Following the sale of the old investment or business property, the sales proceeds must be held beyond the up-trader's "constructive receipt" by a qualified third-party intermediary or accommodator. These third parties are often bank trust departments or large title companies that have set up exchange subsidiary corporations equipped to act as qualified exchange accommodator facilitators.

IRS Regulations say a qualified accommodator can be a third-party who is the exchanger or a "disqualified person," such as an agent of the exchanger within the last two years (such as an employee, attorney, accountant, and real estate agent), a related party (family members or a corporation in which the taxpayer owns more than a 10 percent interest), or a related agent (such as an escrow firm owned by the exchanger's attorney). 

Starker Delayed Exchanges has been an important investment strategy for years for sellers wanting to delay the tax consequences of the sale at hand.

What is TIC - 1031 TIC Exchanges? (Tenant in Common Property)

1031 TIC Exchanges are a form of real estate asset ownership in which two or more persons have an undivided, fractional interest in the asset, where ownership shares are not required to be equal, and where ownership interests can be inherited. Each co-owner receives an individual deed at closing for his or her undivided percentage interest in the entire property. In brief, a TIC owner has the same rights and benefits as a single owner of property.

Although the TIC ownership form has been used for many years, its popularity has been increasing dramatically due to a recent IRS ruling. Exchangers often have difficulty in locating and closing suitable replacement property within the 45 day identification period and the 180 day closing period. 1031 TIC exchanges can significantly reduce these risks.

The Mechanics of a 1031 Tenants in Common Exchange

Investors have long used 1031 exchanges to defer taxes, while swapping old properties for newer properties. The reasons for swapping real estate vary greatly. In today's market, finding real estate values can be a challenge and individual investors have been somewhat limited to residential properties and small commercial structures.

An IRS ruling in 2002 greatly expanded the pool of available properties, particularly for individual investors. The ruling pertains to joint tenant in common (TIC) legal structures or co-owned real estate (CORE), which quite simply, allows individuals to own a fractional interest in a property, such as an office building, apartment complex or shopping center. While tenant in common investment ownership has been around for quite some time, the 2002 ruling allowed investors to feel confident that the IRS was on board with the tenant in common structure for 1031 TIC exchanges, igniting a cottage industry.

The ruling, coupled with an increased interest in 1031 TIC properties, has led to a rapid growth in tenants in common and CORE investments. A 1031 TIC structure will allow investors to pool their resources and purchase larger, higher valued and better positioned properties than they might otherwise have access. Typically these more prestigious properties can also open doors to high quality lessees, such as Fortune 500 companies and government entities, reducing owner tenant risk. Real estate firms (Sponsors) organize the properties with professional management, removing day-to-day owner concerns.

TIC 1031 tenant in common exchanges are typically handled through broker-dealers and are under the oversight of the Securities and Exchange Commission (SEC). While there are 1031 TIC sales occurring outside of the SEC supervision, currently there is quite a bit of controversy over these properties and there may be a movement by the SEC to pull these properties under their regulatory umbrella.

By combining the advantages of a 1031 exchange with the the advantages of tenant in common exchanges (TIC properties) - the marriage of 1031 starker exchange and TIC can allow investors the opportunity to defer their capital gains taxes and upgrade their investment real estate while providing an opportunity to potentially increase their monthly cash flow.  If you are an accredited and pre-qualified investor searching for a Triple Net property, you may consider the potential advantages of investing in a TIC property verses a triple net property.