1031 Exchanges and the IRS

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from www.havenexchange.com

IRS 1031 Exchange - 1031 Reverse Exchange
IRS Ruling Clarifies Use of Tenancy-in-Common Interests in 1031 Exchanges
By Ronald L. Raitz, CCIM
The Internal Revenue Service has released Revenue Procedure 2002-22 earlier this year, which addresses the use of fractional ownership interests, commonly known as "tenancy-in-common" or "TIC" interests, as replacement property in 1031 tax-deferred exchanges.The potential advantages of using TIC interests to complete a 1031 exchange are numerous. These fractional interests make it much easier to identify suitable replacement property within 45 days, provide the chance to own a share of institutional-grade property which might otherwise have been too expensive, and allow an investor with a limited amount of dollars to diversify into multiple properties.
1031 Exchange Information
Under Section 1031, investors in real property may defer gain recognition on a sale by exchanging it for like-kind property and meeting a number of specific requirements. In order to achieve total tax deferral, the cost of the replacement property must be equal to or greater than the net sales price of the property being sold, and all the proceeds must be used.Further, the investor must identify suitable replacement property within 45 days of the relinquished property sale. Finally, the investor must take title to the property he ultimately buys in the same manner in which he gives title to the property he sells. This title requirement prevents investors from buying into larger and potentially more attractive properties when they have to buy shares or partnership interests to complete the acquisition.
Security
Prior to the new ruling, tax professionals were wary of fractional interests as replacement properties because the IRS might consider the investor's interest to be in a partnership, rather than in real property, effectively invalidating the exchange. (Section 1031 stipulates that shares of stock and partnership interests are not qualified property.)In response to the need for high-quality replacement property in a range of prices, a niche group of companies began offering TIC interests to complete 1031 exchanges. To satisfy the title requirements, investors receive a deed for a percentage interest in the property, rather than a share of a partnership. The new guidelines also open the door for investors who want to structure fractional interests in a desirable replacement property on their own, rather than through a sponsored program. A summary of the New Guidelines Rev. Proc. 2002-22 provides guidance on the use of fractional interests as replacement properties in 1031 exchanges. Although the IRS did not provide safe harbor status for these investments, the ruling outlines 15 minimum standards that TIC interests must meet in order to be considered as potential replacement property. The highlights include:
the number of tenants-in-common cannot exceed 35;
the sponsor of the interests may own the property (or an interest therein) for only six months before 100 percent of the interests are sold;
any decision that has material or economic impact on the property or to its owners must be approved unanimously by the owners; and
any management agreements must be renewable annually and must provide for market rate compensation.
For the complete listing of requirements, visit the IRS Web site at www.irs.gov. Investors should seek private letter rulings on specific offerings for more concrete assurance that a certain program qualifies under the ruling.
Careful Review is Required
While TIC programs are in their infancy, tax professionals and other investment advisors should review any program being considered carefully. Because all programs are different and may have been structured before the release of Rev. Proc. 2002-22, careful due diligence is essential.Whether for groups sponsoring fractional interests or creative investors looking to pool resources into a larger property, the new IRS guidelines are good news for the investors who want to enjoy the many benefits of a 1031 exchange.
About the Author Ron Raitz, CCIM, is the president of Real Estate Exchange Services Inc. of Marietta, Ga. He serves on the board of directors of the Federation of Exchange Accomodators (FEA). He may be reached at 770/579-1155, ext. 10 or by e-mail at rees1031@mindspring.com.February/ March 2003 VOL. 48, No. 2