Helaine and Geoff own and manage a 43 unit rental apartment complex in New Haven, Connecticut, that they bought nine years ago for $2,300,000 and which is now worth $5,100,000.
As landlords and rental property managers, Helaine and Geoff have seen it all: vacancies, delinquencies, evictions, nuisance lawsuits, constant tenant demands for repairs, and the rising cost of keeping the property in good condition.
They would like to get out of the landlord and property management business and take advantage of the appreciation in the value of their property.
Geoff’s friend Harold points out to him that by exchanging his rental property for other property in a Section 1031 exchange he could save about $42,000 in capital gains taxes that he would otherwise have to pay to the government in a sale.
Geoff is now excited about using Section 1031. He wants to exchange the apartment complex for shares in a new high-tech company started by a group of Yale professors who have discovered an inexpensive way to make personal computers more than five times faster.
Helaine is also interested in doing a Section 1031 exchange. Her best friends, Betty and Steffie, are real estate agents. Both of them suggest that Helaine and Geoff exchange their apartment complex for tenancy-in-common interests in a mall and an office building.
Helaine tells them she isn’t interested in a tenancy-in-common. In fact, Helaine says, she is absolutely through with property management headaches, and is willing to exchange the apartment complex for just about anything except rental property of any kind.
Can Helaine and Geoff do a Section 1031 exchange with their apartment complex and save $42,000?
What about Geoff’s inclination to exchange the apartment complex for stock in a new high-tech company?
Does the advice of Betty and Steffie to do a Section 1031 exchange of the apartment complex for several tenancy-in-common interests make sense?
What about Helaine’s objection to a tenancy-in-common ownership interest in a mall or office building as just another property management headache?
Geoff and Helaine can exchange their apartment complex under Section 1031, since it is property that has been held for productive use in a trade or business or for investment.
However, Geoff’s plan to exchange the apartment complex for stock in a new high-tech company will not work for a Section 1031 exchange.
Section 1031 applies only to “the exchange of property. . . for property.” To qualify for the tax benefits of an exchange under Section 1031, what is being exchanged must be ownership of tangible property (such as land, buildings,mineral deposits, or uncut timber), not a security (such as stocks and bonds), services, or a lease or rental interest.
Geoff’s proposed investment in a new high-tech company is not an ownership interest in tangible property, and so would not qualify as replacement property under Section 1031.
Helaine should reconsider her objection to a tenancy-in-common ownership interest in a mall or office building as just another property management headache.
In contrast to other forms of real property ownership, TICs allow individual investors to own a percentage of a significantly larger and/or more expensive property, and take advantage of a greater potential for appreciation, than they could as sole owners.
TICs also allow you to use a Section 1031 exchange to diversify your real estate investments, since you can exchange a single relinquished property for TIC ownership interests in several different properties.
As Helaine’s friends Betty and Steffie pointed out, she can exchange her multi-unit rental property for TIC interests in an office building and a shopping mall.
TICs also allow individual investors to own a percentage of rental property, such as multi-family apartment complexes, office buildings, and triple net leased shopping malls without the headaches and hassles of individual property management.
TICs are most often managed by professional management companies, who take over the headaches and hassles of direct property management (collecting rent, avoiding vacancies, negotiating leases, demands for repairs and other tenant complaints, dealing with delinquencies, evictions, zoning issues, and the threat of nuisance lawsuits).
TIC ownership therefore offers the real estate investor the same kind of “arm chair” investing as stocks, bonds, trusts, and other securities, while still allowing for the indefinite deferral of capital gains taxes and recapture of depreciation.
Far from being the rental property management nightmare that Helaine fears, TIC ownership might be exactly the kind of hassle-free real property investment that Helaine is looking for.
To contact Melissa J. Fox about serving as a qualified intermediary or for other 1031 exchange services, send an email to email@example.com