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1031 & TICs

Leveraging 1031 TIC Investments

At 1031 Exchange Place, we understand that the 45-day identification period for selecting a replacement property in a 1031 exchange can be challenging for many investors. A great alternative to ease this process is utilizing a Tenant in Common (TIC) structure, which offers flexibility and the potential to invest in high-value properties with fractional ownership.

What is a TIC 1031 Exchange?

A TIC 1031 exchange, or Tenancy in Common 1031 exchange, allows multiple investors (up to 35) to pool their resources and jointly own a property. This co-ownership model offers each investor an undivided, fractional interest in the entire property, meaning they share in the income, tax advantages, and potential growth.

Key aspects of a TIC 1031 exchange include:

  • Each investor receives a separate deed and title for their share.
  • Investors have the right to sell or transfer their ownership interest without the need for consent from the other co-owners.
  • Investors can have unequal stakes in the property, providing flexibility based on individual investment capacity.

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Advantages of TIC 1031 Exchanges

A TIC 1031 exchange offers a range of advantages, particularly for those looking to diversify their investment portfolio with reduced upfront capital requirements. These benefits make TIC structures highly appealing for investors who may not have the resources to purchase large properties on their own. Some key advantages include:

  • Diversification Across Asset Classes: Through TIC 1031 investments, investors can gain fractional ownership in a variety of property types, such as high-end commercial real estate, medical facilities, retail centers, or industrial warehouses. This diversification helps reduce risk by spreading investments across different sectors and geographic regions.

  • Access to Institutional-Grade Properties: By pooling resources with other investors, you can acquire shares in larger, institutional-grade properties that would normally be inaccessible to individual investors. Properties like office towers, shopping malls, or luxury apartments are now within reach, giving you the opportunity to participate in high-value real estate markets.

  • Lower Investment Thresholds: With a TIC 1031 property, the minimum capital required from each investor is substantially reduced. For example, rather than needing several million dollars to acquire a property outright, you can invest a smaller portion of the total cost. This feature makes it easier for more investors to participate in high-value transactions without over-leveraging themselves.

  • Passive Income Streams: Since TIC 1031 investments often involve professionally managed properties, you can benefit from passive income without the need for hands-on management. Rental income and appreciation are distributed according to each investor’s share in the property, providing a steady stream of passive income while allowing you to focus on other ventures.

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Example of a TIC 1031

Let’s illustrate the power of a TIC 1031 with a practical example:

Imagine you own a small apartment building and recently received a $700,000 offer to sell it. While you want to reinvest the proceeds in a larger, higher-quality property, you realize that your $700,000 might not be enough to secure a premium investment like a downtown office building or luxury retail space on your own.

Instead of purchasing an entire property outright, you can leverage a TIC 1031 exchange. For instance, by using that $700,000 to purchase a 15% fractional ownership in a $5 million office building, you gain access to a significantly more valuable property. This allows you to defer capital gains taxes while acquiring an interest in a high-grade commercial asset, benefiting from rental income and potential appreciation.

In this scenario, the office building may be generating significant income from long-term leases, and with the TIC structure, you share in both the income and the property’s appreciation—offering you the financial benefits of a high-end property with a manageable investment amount.

Rules for a Successful TIC 1031 Exchange

To ensure that your TIC 1031 exchange qualifies under IRS rules, you must adhere to several important guidelines. Failing to meet these criteria could jeopardize your ability to defer capital gains taxes through the exchange. Here are the key rules:

  • 35 Investor Limit: The IRS limits the number of co-owners in a TIC 1031 exchange to 35 participants. This cap ensures that the property retains the necessary characteristics of co-ownership rather than becoming too complex, which could disqualify it from 1031 exchange eligibility.

  • Full Reinvestment of Sale Proceeds: In a TIC 1031 exchange, 100% of the proceeds from the sale of the relinquished property must be reinvested into the new property. Additionally, the value of the replacement property must be equal to or greater than the value of the property you sold, ensuring that all capital is fully deployed in the exchange.

  • Annual Renewal of Management Agreements: Any property management agreement associated with the TIC must be renewable annually, with terms that reflect market-rate compensation. This rule ensures that the investors maintain control and the management agreement remains fair and competitive.

  • Co-Owner Voting Rights: All TIC co-owners must retain voting and approval power over major decisions related to property management, refinancing, leasing, and potential sale of the property. This prevents any one party from having undue control, protecting the interests of all investors.

  • Debt and Proceeds Distribution: When the property is sold, any secured debt must be fully satisfied before the remaining sales proceeds are distributed to the co-owners. This ensures a fair and structured conclusion to the investment.

Minimizing the Drawbacks of TIC Investments

While TIC 1031 exchanges offer several benefits, they also come with potential drawbacks, especially when it comes to decision-making and liability. However, there are ways to mitigate these risks:

  • Management Complexity: One of the primary challenges in a TIC 1031 exchange is the need for unanimous approval from all co-owners on major decisions such as refinancing or selling the property. This can lead to delays or disagreements that hinder the progress of the investment. To minimize this, careful selection of co-owners and a well-drafted TIC agreement can reduce the chances of conflict.

  • Liability Concerns: Under a TIC structure, each investor could be held personally liable for the property’s debts or losses. One way to mitigate this risk is by setting up a Single Member LLC (SMLLC) for each investor’s ownership interest. The SMLLC acts as a “disregarded entity” for tax purposes, meaning it satisfies 1031 exchange requirements while also providing personal liability protection.

  • Shift to Delaware Statutory Trust (DST): Many investors choose to reduce the drawbacks of TIC investments by opting for a Delaware Statutory Trust (DST) structure instead. DSTs eliminate some of the management challenges of TICs by centralizing decision-making with the trustee, thus simplifying the process and minimizing co-owner disputes. Moreover, DSTs allow for an unlimited number of investors, making it easier to purchase larger properties and spread out the investment risk.

By understanding the rules and taking appropriate steps to address these potential pitfalls, you can maximize the benefits of tenants in common and 1031 exchanges and make smarter investment decisions for your portfolio.