Every investor is worried about the tax consequences on a particular investment. However, every problem has a plausible solution. The IRS’s guidelines on 1031 Tenants in Common Exchange have benefited many investors by letting them defer capital gains tax. Tenants in Common, popularly known as a TIC, is one of the proven ways used by investors to gain ownership of one or more high performing real estate while preserving wealth and getting away with the arduous task of property management.
Let us consider the following example to understand TIC investments in detail –
Say, you closed a deal and have $400,000 in gain and $400,000 in net proceeds. Practically, a $400,000 capital gain may result in a tax liability of almost $140,000, including federal tax, state capital gain, depreciation recapture, and income tax on the proceeds from the property’s sale. After taxes, you will have $260,000 to reinvest in a different property.
However, if you choose to a 1031 exchange on the property, you can reinvest the entire equity of $400,000 to purchase $1,600,000 real estate.
A 1031 exchange works as a game-changer in this case!
It’s clear from the above example – a 1031 or like-kind exchange lets investors defer capital gains tax, promote meaningful portfolio growth, and earn more income.
However, you must get the due diligence done before investing in TIC properties. You must have a trusted attorney to review the documents or a 1031 exchange expert to guide you throughout the transaction. You, being the investor, should check the credibility and experience of the Sponsor involved.
1031 Rules for a Tenants-in-Common investment –
You must abide by the IRS rules to defer capital gains and depreciation recapture taxes successfully. Your old or previous property must be an investment property, and it must have been used for trade or business purposes.
You must fulfill the following requirements to get the benefits of a TIC 1031 Exchange –
- You must reinvest the entire sale proceeds, and the cost of the replacement property must be greater than or equal to the selling price of the relinquished property.
- Your Qualified Intermediary acts as the authorized seller of your property and keeps the proceeds after the sale.
- Your 45-day identification period is extremely crucial. You can identify up to three replacement properties in writing within these 45 days.
- The 200% Rule lets you identify any number of replacement properties only if the identified properties’ net value does not exceed 200% of your previous property’s value.
- If the three-property rule or 200% rule is not applicable, the identified properties’ total value needs to be at least 95% of your previous property’s value.
Why is time crucial in 1031 exchanges?
Once you have locked your new property, you are left with another 135 days to acquire the same. If your tax return day falls before the 180th day, then you must complete your 1031 exchange by that date.
You should keep in mind that the total exchange period of 180 days also includes the 45-days identification period. Whether the 45th day is a holiday or a Sunday, you must complete the identification on or before that day. You will not be able to reap the benefits of a 1031 exchange, and your transaction will no longer be valid if you missed the deadline.
If you invest in more than one asset, make sure that you get to acquire all of them before the 180th day.
Who should be your TIC sponsor?
You must hire a licensed investment representative specialized in TIC investments before you sell your previous property.
You must evaluate as many options as possible and choose an ideal replacement property. A well-planned investment is always better than sudden decisions. Your Sponsor should have a proven track record in the real estate investment market.
Your investment representation should have a Series 7 or Series 22 license, along with either a Series 63 or Series 66 license. He/she must also have considerable experience in income-producing real estate and have arranged several successful TIC exchanges.