Few would deny that real estate is a solid investment. It provides an attractive combination of stability, reliable cash flow, preservation of principal and capital appreciation. However, many investment property owners nearing retirement find themselves in a quandary. They are equity rich, but cash poor, with increases in the value of their property far outpacing income growth. They also are often tied down by the day-to-day issues of property management and, particularly in cities like San Francisco, California, shackled to the constraints of rent (and eviction) control. In fact, San Francisco is home to some of the lowest cash return on equity in the state’s real estate marketplace, which is somewhat counter-intuitive given California’s ever-booming property market.
The obvious answer is to sell the property and unleash the dormant equity, but that can be problematic. These investors face the reality of prohibitive capital gains taxes and recaptured depreciation, as well as the task of identifying an alternate investment venue; or locating, acquiring and financing suitable replacement property in the time period allowed, taking advantage of tax deferral under IRS code section 1031.
An ideal solution for many investment property owners may be to reinvest the proceeds from the sale of their property and utilize a subsequent 1031 tax exchange into a tenancy-in-common (TIC) ownership type, also known as co-ownership of real estate (CORE) interest in a suitable replacement property.
1031 exchanges, also known as Starker exchanges or tax-deferred exchanges, permit owners to sell investment property and defer tax payments by reinvesting the proceeds into another investment property (or investment properties). In order to completely defer the payment of tax, among other things, the replacement property must be of equal or greater value and all the equity from the sold property must be reinvested in the new property. The marriage of 1031 exchange and TIC/CORE allows investors not only to defer their capital gains taxes but also to upgrade their investment real estate.
TIC/CORE is a way of sharing ownership of property among two or more persons whereby each tenant holds an undivided interest in the property. Tenants-in-common may own interests of differing sizes. TIC/CORE investors are on the title and considered separate owners of the real estate. They share pro rata in the income, tax benefits and appreciation of the property. Their TIC/CORE interest can be purchased, sold, gifted, bequeathed by will or inherited; and it is subject to property taxes, gift tax, and estate and inheritance taxes in the same manner as any property held in sole ownership. With a TIC/CORE property, each of up to thirty-five investors have the opportunity to own an undivided fractional ownership interest in an investment-grade property, such as an office building, shopping mall, apartment complex or industrial property, costing anywhere from $10 million to $150-plus million.
The benefits of investing in TIC/CORE properties are substantial. Such properties employ professional asset and property management, relieving the investor of day-to-day tenant headaches. More important, investors often receive greater cash flow and overall returns than they had in their previous sole ownership property. Typically, many people receive between 2-3 percent of their equity in their property in rental income. By selling this property and placing the equity into a larger investment-grade property, they can potentially experience annualized cash flow from 6-8 percent, paid monthly, and 12-16 percent overall return on their investment. Also compelling is that TIC/CORE exchange investors can diversify among several property types, and geographic locations through fractionalized ownership, while still enjoying 1031 exchange benefits on each amount. Thus, investors can potentially reduce risk in their overall real estate portfolio.
Investors seeking to exchange for a TIC/CORE property are best advised to work with a financial advisor experienced in 1031 exchanges. Such advisors work closely with top real estate providers, who give the investor access to the best properties available. In addition, many TIC/CORE opportunities have pre-arranged, non-recourse financing in place, which is perfect for investors working within the 1031 exchange time frame. Numerous hours of upfront investigation, evaluation, due diligence and life cycle planning transpires before a property is offered to an investor group. Investors faced with only a 45-day window to identify a suitable replacement property to complete a 1031 exchange can select a suitable project with confidence.
Given the tax deferral, institutional-grade quality of the property, professional property management and pre-arranged, non-recourse financing aspects, a 1031 tax exchange replacement property structured as tenancy-in-common ownership can be a very wise and profitable solution. It allows the investor to maintain everything they like about real estate (monthly income, preservation of principal, capital appreciation, etc.), while eliminating most of the hassles of property ownership.
