THE CASE FOR THE IRS SECTION 1031 TAX DEFERRED EXHANGE AND THE TIC

BY

Ron Ringlien

This is an article for investment property owners to provide information about the IRS Section 1031 tax deferred exchange into Tenant in Common ("TIC") real estate investment structures.  This information is for advisory use only, is purely educational and not to be taken as either tax or investment advice.

What is this about?

We are providing this to you because you own investment type real estate. There is an efficient process that allows you to sell your investment property and reinvest the proceeds of sale in another investment property or properties without paying taxes on your gain from the sale of your appreciated property. We would like to acquaint you with that process.

Why would I want to sell my investment property?

There may be a number of reasons:

• You are tired of the day-to-day responsibilities or ownership and management.
• You feel that the property is fully appreciated.
• You may be facing substantial expense to rehabilitate or upgrade your property.
• Your cash flow from the property has not kept up with its value.
• You have used up all or most of the depreciation on the building.
• You would like to own a better property in a more rapidly appreciating area
• You would like to diversify your investment real estate portfolio, geographically or by property type, or both.

What is this 1031/TIC process?

This is a three part process that involves the sale of the "old" property and the opening of an IRS Section 1031 non-simultaneous exchange, where a Qualified Intermediary (QI), or Accommodator, holds the proceeds of sale from the old property and prepares the exchange documents. The third part of the process is the TIC which is the "new" or replacement property that is purchased with the sale of the "old" property money held by the QI.

The tax deferred exchange has been around for some time, but the ability to do a non-simultaneous exchange only really dates beck to 1991 when Congress created the current Section 1031, although there were the "Starker" type exchanges done since the early 70´s, but with much IRS challenge. The TIC is a relatively new entity, with the formal TIC industry launched in 2002, when the IRS published a set of guidelines that created the TIC as an IRS accepted entity.

While IRS Section 1031 offers a way to defer taxes on your highly appreciated investment or business real estate, the path to finding single-ownership "new" or "replacement properties" in the Section 1031 exchange can be difficult. The TIC offers you a "turn key" solution to the replacement property issue. A pioneer in the 1031/TIC business recently stated, "Approximately half of all 1031 exchanges completed by individuals within the next 10 years will be TICs."

One of the primary tenets of wealth accumulation and preservation is; "pay taxes later!" The 1031 exchange coupled with the TIC offers an efficient path to accomplish this.

What is a "TIC?"

A TIC is shorthand for a "Tenant-in-Common" real estate investment ownership structure. This ownership form is one of the oldest forms of real estate ownership that has been recently rejuvenated by the IRS in a 2002 Revenue Procedure. This 2002 IRS Rev. Proc. said that a TIC interest would qualify as "replacement property" in a Section 1031 real estate exchange if 15 specific requirements were met. This IRS ruling gave wings to a fledging TIC industry that had been operating since 1994 as a small number of primarily Southern California real estate companies, creating TICs with no overt IRS guidance. Since 2002 the TIC industry has grown in leaps and bounds to a total $5.5 billion of equity raised in 2006

A TIC can be defined as a directly-owned, passive, group-ownership, prepackaged real estate investment that can be divided into no more than 35 fractional ownership interests. One of the attractions of the TIC is that these ownership interests can be unequal, which accommodates 1031 exchanges of differing values. It is important to differentiate the TIC from a real estate investment partnership, because a partnership does NOT qualify with the IRS as "like kind" property for a Section 1031 exchange.

The TIC Difference

The 1031 tax deferred exchange offers some valuable investment benefits in its own right including a new depreciation basis and deferment of taxes due on gain if the real estate were to be sold outright. While most gain is taxed by the Federal Government at the 15% long term capital gains rate and by the State of California at a maximum of 9%, tax on the recapture of depreciation is often overlooked. This item is taxed at 25%. So, if you have a high proportion of depreciable value versus land value, the total tax upon the sale of such an asset could be significant.

If one only thinks of the Section 1031 exchange as a way to defer the tax on the sale of his/her real estate, he/she is missing a major benefit of the 1031 exchange. The 1031 exchange allows you to make money off the tax you would have paid if you had sold the property and not done an exchange: In essence, a potentially lifelong loan from the Federal and State Governments to you to acquire real estate.. The non-recourse financing inherent in most TIC structures can potentially add significantly to further wealth accumulation in the 1031/TIC process.

In addition to the inherent value of the 1031 exchange, the new property to be acquired to replace the old property represents the opportunity to preserve and grow the wealth that you have created over a lifetime of nurturing your real estate investments. So, just finding any old replacement property is not acceptable in this transition from active ownership to passive ownership. Also, it is often difficult to find a replacement property to match up with your 1031 investible equity. Enter the TIC as the ideal replacement property.

The TIC offers advantages over most other replacement properties as long as you do not want to be involved in active management of the replacement property and do not have a need to drive by the new replacement property every day just to see if it is still there. The TIC offers control and transparency not found in other group type investment structures. The TIC investor has veto rights, subject to "super-majority" rule, as to the sale, re-financing or leasing of the TIC property. In addition, the TIC offers the following advantages as a replacement property:

• Management-free ownership- You receive a monthly check with no property management or rent collection issues.

• Ease of investment-TICs are prepackaged with properties acquired, financing in place and all due diligence completed.

• Flexibility-TICs can accommodate varying equity investment to match your 1031 reinvestment need.

• Non-recourse financing- Financing for TIC properties is almost always non-recourse to the investor.

• High quality property- TIC properties are generally of a quality only available to institutional buyers.

• Diversification-You client can invest in several different TICs offering different property types and geographic diversity.

• Higher growth-Many TICs have property acquisition teams that scout nationwide for the best properties in the faster growing geographic areas.

• Deeded interest-You client receive a deed for your interest that can be transferred.

• No special allocations-Each TIC investor receives cash distributions, sale proceeds, refinance proceeds and depreciation tax benefits according to his/her percentage ownership.

FAQs:

Q. Are TICs securities or real estate?

A. The great majority of TICs are offered as securities, with only a handful of companies offering TICs as real estate. This is a hot topic within the TIC industry.

Q. What is the minimum equity investment required in a TIC?

A. In general terms, those TICs that are sold as securities require minimum equity investments from $400,000 on the low side to $1,500,000 on the high side. Those TICs that are sold as real estate require minimums in the $150,000 range and usually have maximums in the $250,000 range. Individual TIC deals often fall outside these stated parameters.

Q. How do I get help with TICs?

A. The best way is to work with someone who specializes in TICs because of the broad diversity of the many TIC sponsors and deal structures.

Q. What else should I know about TICs?

A. There several important issues regarding TICs. One of these is the timing issues inherent in 1031 exchanges (the properties to be acquired through the exchanged must be identified within 45 days of close of escrow on the old property, and escrow must close on the new properties within 180 days of sale of the old property); another is the limited number of investment slots (no more than 35) available in each TIC deal. Another important issue is the fact that not all sponsors have TIC offerings available at all times

Q. What are some of the issues specific to individual TIC offerings?

A. Some of the areas to understand in TIC deals are:

• the master lease vs. pro-forma lease projections
• the TIC vs. the Delaware Statutory Trust (DST)
• institutional property vs. non-institutional property
• the due diligence process
• sequential closings
• the fee structure
• the financing structure

Q. How many firms sell TICs?

A. If you look in all the corners and under the rug, you might find as many as 100 firms that sell TICs. It is not the number that is important, but the knowledge to understand how each firm operates and the type property in which it specializes.

Q. What else should one be aware of in the 1031/TIC process?

A. Perhaps the most critical factor in the 1031/TIC process lies in the 1031 exchange area. The selection of an appropriate Qualified Intermediary (QI), or Accommodator, to handle the exchange is essential. QIs, while handling large amounts of money, are unregulated by any government entity. The IRS does not define who may be a QI; it only defines who may not be one. In essence a QI must be totally independent, so a QI cannot be a family member or the client´s attorney or CPA. Also, consider using entities rather than individuals and check to see if the QI is bonded. One source indicates that of the some 2,000 QIs in the US, only 39 are bonded as QIs. Under current IRS rules, a convicted felon could be a QI. This is an area in which one should use great care.

This information has been published by Peak Securities Corporation, Member, NASD/SIPC.  Although the facts contained in this article have been verified, there are also general opinions that have been asserted that are those of Peak Securities Corporation.  No information contained in this article should be relied upon by anyone without discussing the specific circumstances with a tax or investment advisor.

Ron Ringlien is a 30 year real estate broker who is also a licensed securities representative specializing in TICs with Peak Securities Corporation. Ron can be reached at 562-430-3796 in Seal Beach, CA, or "rcringlien@attglobal.net."

Securities offered through PEAK SECURITIES CORPORATION, 10225 Ulmerton Road, Suite 3D, Largo, FL 33771, 727-536-7100. Member, NASD/SIPC.

Further mandated disclosure: Tenant-in-Common property investments are subject to substantial risk and are therefore only available to accredited investors with sufficient net worth and income. Real estate risk factors include, but are not limited to: limited liquidity, inability to keep the property leased, inability to maintain debt payments, inability to refinance, inability to meet operation expenses, personal liability for "bad boy" carveouts to the non-recourse liability of a loan, failure of other tenants-in common to perform, inability to sell a property for more than the purchase price of the TIC interests, and changes in economic climate, any one of which may resulting the total loss of capital invested.

WORKING WITH "TRUSTED ADVISORS"

I have a good friend with whom I share business ideas. We often critique one another as to how we are conducting our business. As it relates to TIC TRACKS, he tells me that while he loves the topicality and education content of the articles, he feels that I am not clearly conveying the message as to what I actually do to help the Trusted Advisors with their clients in the 1031/TIC area: In essence, that I do not "ask for the business!"

So, Ed here goes! I get paid for selling TICs. But, I do not sell in the traditional manner: my job is to determine if there is a "fit" between your client and his/her financial needs and emotional attachments and all of the moving parts involved in the Section 1031/TIC pathway; then to determine the most efficient way to accomplish the goals of your client. "No Fit: No Sale!"  This is a counseling-based approach to 1031/TIC. I choose to do this through you as a Trusted Advisor, by meeting with you and your individual client, or by helping you create "client appreciation gatherings" or "client education seminars."

I look for the opportunity to help you help your clients in all aspects of a potential 1031/TIC transaction from education to counseling to real estate brokerage to acquiring the TIC.

This information has been published by Peak Securities Corporation, Member, FINRA/SIPC.  Although the facts contained in this article have been verified, there are also general opinions that have been asserted that are those of Peak Securities Corporation.  No information contained in this article should be relied upon by anyone without discussing the specific circumstances with a tax or investment advisor.