While 1031 Exchanges are broad in terms of the variety of tactics that can be executed, the guidelines proposed by the Internal Revenue Service are not flexible in any way. Failure to conform to IRS standards may result in either a failed Exchange, in which case the entire tax liability will be due, or a partial exchange, where only a portion of the tax liability will be required. This article denotes some basic ownership rules of a 1031 Exchange.
The quickest and most straightforward method of acquiring property is to do so yourself, whether you pay cash or a mortgage. Although you'll be restricted to what you can afford, the advantage is that you won't have to worry about other investors pulling out or arguing about when to sell their investments.
It's one possible reason why investors might prefer to invest in a series of lower-priced properties rather than a single high-value asset. However, this would necessitate additional maintenance, and to complete a 1031 exchange on each property, you'll need to find a replacement within a short time, which can be difficult.
Working with a partner or small group of investors increases your ability to afford bigger properties; however, the downside is that the greater the number of investors you have, the greater the likelihood that those investors will have conflicting goals.
There are still solutions available in circumstances when the members of an LLC seek to separate after the sale of the business. Alternatively, you may negotiate a drop and swap in which one member leaves the partnership but continues to hold title to the property as a joint tenant in common. Hence, your piece of the property would be divided at closing, and you might choose to switch to a different home as part of a like-kind exchange.
Tenancy in Common (TIC)
A tenancy in a typical relationship allows you to include different percentages of investors and modify those percentages: one investor can buy out the others, one investor can depart, and a new one can join, and so on. A TIC structure simplifies the procedure, whereas a shared tenancy requires the property to be sold and the legal companies to be altered if one of the investors leaves.
Because the regulations involving survivorship and bequeathing an ownership share are flexible, this form is beneficial for those planning to own property until their deaths. Small groups of investors who want to own a property together but have different aims or intentions for the future may benefit from a TIC arrangement.
A 1031 exchange permits you to sell a piece of real estate and invest the earnings in a new property without paying capital gains taxes on the sale. But what if you wish to modify your replacement property's ownership after exchanging it?
The individual who carried out the exchange is required by Section 1031 to keep their replacement property for investment or business purposes. As a crucial rule of 1031 exchanges, you must ensure to follow it. If you buy a replacement property in a 1031 exchange and then sell it to someone else, the IRS may consider you to have broken the rules and cancel the exchange, leaving you with a huge tax bill.
The best advice is to keep your replacement property for a long time before changing hands. The length of time depends entirely on your circumstances and the property in question.