1031 Exchange – The Most Common Mistakes!

A property transaction related to a 1031 exchange into a Tenant in Common property could have a great impact on the financial stability of a person. Any mistake or a wrong decision in regards to a 1031 exchange can put you in deep trouble, besides unexpected financial liabilities.

It is often seen that most people interested for a 1031 exchange into a Tenant in Common property commit certain basic mistakes that jeopardize the whole transaction or results in a complicated legal situation leading to the client paying a huge tax or penalty amount.

Before I tell you about these common mistakes, let me first explain in brief what is 1031 exchange and how it helps.

Section 1031 of the IRC gives a chance to real estate buyers to defer the capital gain taxes that they incur by selling a property. It states, a real property owner can sell his property and then reinvest the proceeds to purchase of like-kind property and defer the capital gain taxes. Like-kind exchange is considered as one of the best-kept secrets of the Internal Revenue Code and very few CPAs, lawyers and financial advisors have proper knowledge about this.

By doing a 1031 exchange into a Tenants in Common (TIC) property, you can become a part owner of a large commercial property managed by professionals, who pay you a monthly income for the property. This is favorable for most people because it has got fewer strings attached compared to private annuity trusts, charitable trusts etc.

There are 3 Major mistakes that are generally committed by people going for a 1031 exchange into a Tenant in Common property.

a) Ensure that your investment company has their act together. Ask them for their history in TIC offerings, check referrals for satisfied clients. A good and experienced investment company should be able to provide you with multiple references of satisfied clients. Also check the properties available with them, a good investment property would only pick the best properties – good real estate properties are hard to find and sells fast. While mediocre or small investment companies will deal with B grade or less desirable properties, the good investment firms will have only the best properties on offer.

If you are planning to do it privately, be cautious about getting into a Limited Partnership where only one or two members make all the decisions. Another alternative to could be to get a group of friends together and do it all by yourself, however, that is feasible only if you have extensive experience with commercial property and property management.

b) Choose a well-experienced qualified intermediary. A qualified intermediary is extremely instrumental in the successful completion of a 1031 exchange for Tenants in common property. They need to be well conversant with 1031 exchange rules. They ensure that all documentation and money transfer meets the guidelines set for the by section 1031 of the IRS.

Your Accommodators will set up your LLC. It is suggested that you should not work with an accommodator with whom you have an existing relationship. Your family attorney or estate planning attorney may not qualify as your accommodator. A small mistake here can lead to a hefty bill for taxes or penalties by the IRS, or even worse, the whole transaction might fail due to the incompetence of your accommodator or qualified intermediary.

c) Don’t try to cut corners on your property management company. This is extremely important for profitable performance of your investment. You will have to depend on your property management company for the day-to-day problems that will arise; they will be responsible for paying your property taxes in time and maintaining your building. Your property management company should be able to offer you a long term Triple Net Lease that has detailing of your annual income percentage along with scheduled increase. Only reputable management companies would be in a position to offer this. It is worth spending on a good property management company as you get a much higher return on your investment with them compared to any startup. Let your management company have a small profit because their performance is directly related to your investment stability and is going to get you multiples of that amount.

If you are hiring an experienced property management firm it is always a win-win situation of both the parties and you are sure to make the best out of your investment.

Avoid these common mistakes while planning your investment for 1031 exchange into Tenant in Common properties and you can ensure a continuous flow of monthly income while your investment experience a steady growth.