The world of real estate investing is one of the most varied asset classes that investors can choose to participate in. While you’re probably already keenly aware of the different types of real estate that you can invest in, it’s helpful to understand all of the ownership structures that exist within the world of real estate investing. It’s also important that you understand what your rights are as a property owner, and how you can use the funds generated from the sale of one property to purchase subsequent properties so your portfolio can continue to expand.
The Federal Tax Code allows for real estate investors to exchange one type of property for another with no tax ramifications under a 1031 Exchange. Even if you understand 1031 Exchanges, you may have other questions revolving around what you can do with the profits generated from the sell of a property, including whether or not you can use those funds to purchase a fractional interest in other properties. This not only requires an understanding of tax regulations, but also of the different ownership options that exist.
What is TIC Ownership?
One such example of real estate ownership is referred to as Tenancy in Common, often represented by the acronym, “TIC.” Under TIC ownership, you own a fractional share of a subject property (or multiple subject property) with one or more other investors. Since fractional ownership is at the heart of TIC ownership, this type of structure is usually reserved for larger subject properties such as apartment complexes, shopping malls, and other large properties that allow the owners to share in the rents paid by the tenants.
What is DST Ownership?
Delaware Statutory Trusts, often referred to as DSTs, are another option for investors who want to own fractional interest in real estate. DSTs also provide opportunities for multiple owners to have an interest in one or more subject properties. However, DST ownership allows for one to take part in 1031 Exchanges at their own discretion.
Can You 1031 Exchange Into Fractional Ownership?
Assuming that you have at least a working knowledge of 1031 Exchanges, understanding these two fractional ownership structures now poses questions about the legality of 1031 Exchanges being used to purchase fractional ownership in a subject property.
Before we dive into the legalities and technicalities, let’s go ahead and answer the question at hand. Yes, you can use a 1031 Exchange to purchase fractional ownership in a piece of real estate. However, certain conditions must be met.
The most important aspect of doing a 1031 Exchange is based on the requirement that the investor must purchase a property that is of equal or greater value than the one that has been sold. Essentially, this requirement is the IRS’ way to ensure that you don’t sell a property for $250,000, purchase a share in another property for $100,000 and escape taxation of the remaining $150,000.
The other legality to consider is that the fractional purchase must be in a piece of property, not in a piece of a business. With that in mind, if you sell a property and decide that you want to 1031 Exchange your way into fractional ownership, you will be legally required to purchase ownership shares in something like a TIC or a DST.
Operating legally and ethically can be an important part of pursuing success as a real estate investor. Not only does it help ensure that you’re protecting your reputation as an investor, but it also precludes you from facing the legal trouble associated with not following the framework of the Federal Tax Code.