What Are Fractional 1031 Replacement Properties?
When we here at Realized use the terms “fractional 1031 properties” or “fractional 1031 investments,” we are NOT referring to timeshares, shared vacation home arrangements or other “fractional interest” properties. For Realized, “fractional 1031 investments” refers to co-ownership in one or more properties by multiple 1031 exchange investors. Two ownership structures have been approved by the IRS for Fractional 1031 Investments, the Delaware Statutory Trusts (DST) and Tenants-in-Common (TIC). Realized coined the term Replacement Property Interests (RPI)™, which has the same meaning.
1031 Exchange Rules Explained
If you know anything about the IRS, it’s that they love making rules. Unfortunately for most of us, they don’t always make them easy to understand. A 1031 exchange is a major financial transaction for most investors, and given the consequences, one where you want to play by the rules. Let’s break down the key 1031 exchange rules in layman’s terms:
Replacement Property Options for 1031 Exchange Investors
As you may have already figured out, a 1031 exchange offers real estate investors a powerful tool to build wealth by deferring capital gains and depreciation recapture taxes when they sell an investment property. Investors accomplish this by reinvesting the proceeds from the sale of a property into another qualifying real estate investment.
Benefits and Risks of Investing in NNN Properties
A Single-Tenant Triple Net (NNN) property is an attractive investment option for a variety of investors. The NNN structure provides consistent income with minimal management obligations. In many NNN lease properties, the investor’s only responsibility is collecting their rent check! However, no investment is risk free, including NNN properties. If thinking about investing in a NNN property, investors should consider the following:
How Does A Mortgage Affect Real Estate Investor Returns
Commercial real estate is a relatively high dollar asset class, with even “small” properties costing hundreds of thousands of dollars. This is why investors almost always finance a portion of the purchase with a mortgage. Mortgages enables investors to acquire larger properties, but how else does it impact an investment? By way of example, let’s look at the impact of debt on the cash flow, principal reduction and appreciation of hypothetical investment properties.
Three Notable Problems with 1031 Exchanges
There are many rules and regulations that govern the completion of a 1031 exchange, which often make the process nerve racking for investors. Fortunately, there are many resources available to investors, including the Realized guidebook on the 1031 exchange process. Below are three common challenges of 1031 exchanges and potential solutions for each.
What Is A TIC And How Are They Used For 1031 Exchanges?
“TIC” is an acronym referring to Tenant-In-Common (TIC) investments in properties by multiple 1031 exchange investors. Tenants-In-Common, is a legal term that describes a form of ownership by more than one party in real estate, or any asset. In this case, the term “tenant” means a co-owner of a property, and not someone that rents the property. The distinguishing features of the tenants-in-common ownership form are: All tenants (co-owners) hold an individual, undivided interest in a property; Ownership may be held in unequal shares; Each ownership interest may be separately sold or mortgaged; and Upon death of a tenant, the interest of the deceased will pass to their heirs.
History of the 1031 Exchange
If you're just learning about 1031 exchanges, a good place to start is section 1031 of the Internal Revenue Code (IRC), which states that if an investment property is exchanged for a “like-kind” investment property, taxes on capital gains can be deferred. For this reason, a 1031 exchange is an excellent wealth-building strategy, leaving investors with more equity to reinvest in more valuable properties.
Investment Properties That Don't Qualify For a 1031 Exchange
When you sell an investment property for more than what you paid for, you will likely incur a capital gain and have to pay taxes on it at the time of sale. However, Internal Revenue Code Section 1031 provides an exception to this rule if you reinvest your capital gains into a similar property. This type of transaction is referred to as a “like-kind exchange," allowing you to defer the taxes you would have otherwise had to pay. Fortunately, the exchange rules are fairly broad and allow investors a great deal of latitude in their choices.
Tenants-in-Common vs. Delaware Statutory Trusts
The IRS has blessed two legal structures that allow multiple, unrelated 1031 investors to invest in the same replacement property. They are Tenants-in-Common (TIC) ownership and Delaware Statutory Trusts (DST). Though both structures permit groups of investors to pool their equity to acquire replacement properties on a tax-deferred basis, the similarities largely stop there.
