[1031 exchange into TIC] Cost basis and Depreciation

1031 Exchanges
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[1031 exchange into TIC] Cost basis and Depreciation

JJ O.
San Francisco, CA · Member since 2013 · 30 posts · 6 votes

First off, thanks to everyone for contributing.  I've learned just about everything I know about real estate on BiggerPockets.

My situation:  I'm trying to help my parents use a 1031 exchange to defer ~1.2M capital gains on the sale of a fully-depreciated rental property.  We are still in the research phase and considering all of the ideas presented in this forum.

Question: How would the adjusted cost basis/depreciation work with a 1031 exchange into a tenant-in-common (TIC) investment? Our share of the property would be ~$5M. The asset manager/potential partner told me to expect an annual K-1 form for filing taxes. If all you get is a K1, how would you report the adjusted cost basis on your taxes? How is the deferred capital gain liability captured?

Second Question: What would happen when one invests in a DST?

Thanks in advance!

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
5y

@JJ O., I think you and talked through this.  Your question is very relevant because there are so many investors wanting to become more passive and so many passive opportunities that won't qualify for 1031 treatment.  

A tenants in common investment is fine working with a 1031 because you are actually purchasing real estate.  a tenant in common is a % ownership of a larger real estate.  But you actually own the real estate.  When that asset manager told you that you were going to get a K-1 that does not indicated a tenant in common ownership.  It indicates that you have purchased a membership interest in a company that owns real estate.  And that does not qualify for 1031 treatment.  There are some conversion programs where they can offer you a tic ownership to complete your 1031 and then you convert that into their LP.  But even then you have to understand that when they later sell you have forfeited your opportunity to do another 1031.  And you will pay tax not only on the profit the LP makes but all of the profit you deferred in the 1031.

DSTs are another matter because that structure of the Delaware Statutory Trust has been specifically blessed by the IRS to be equivalent of ownership of the actual real estate itself.  So the most available truly passive way to use 1031 is to move into DSTs.  They still give you all of the ownership benefits of real estate ownership.  And when the project reaches its full cycle you can again 1031 out of them and into any other kind of investment real estate.  Which you cannot do with a syndication.

The middle range of passivity would be NNN commercial real estate investing. In these the tenant pays all taxes insurance and maintenance. But you as the owner must manage the tenant. These leases are typically much longer (think decades) than normal residential leases. And the parent company tenants very large with sophisticated systems to take care of your property.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @JJ O., I think you and talked through this.  Your question is very relevant because there are so many investors wanting to become more passive and so many passive opportunities that won't qualify for 1031 treatment.  

    A tenants in common investment is fine working with a 1031 because you are actually purchasing real estate.  a tenant in common is a % ownership of a larger real estate.  But you actually own the real estate.  When that asset manager told you that you were going to get a K-1 that does not indicated a tenant in common ownership.  It indicates that you have purchased a membership interest in a company that owns real estate.  And that does not qualify for 1031 treatment.  There are some conversion programs where they can offer you a tic ownership to complete your 1031 and then you convert that into their LP.  But even then you have to understand that when they later sell you have forfeited your opportunity to do another 1031.  And you will pay tax not only on the profit the LP makes but all of the profit you deferred in the 1031.

    DSTs are another matter because that structure of the Delaware Statutory Trust has been specifically blessed by the IRS to be equivalent of ownership of the actual real estate itself.  So the most available truly passive way to use 1031 is to move into DSTs.  They still give you all of the ownership benefits of real estate ownership.  And when the project reaches its full cycle you can again 1031 out of them and into any other kind of investment real estate.  Which you cannot do with a syndication.

    The middle range of passivity would be NNN commercial real estate investing. In these the tenant pays all taxes insurance and maintenance. But you as the owner must manage the tenant. These leases are typically much longer (think decades) than normal residential leases. And the parent company tenants very large with sophisticated systems to take care of your property.

    The 1031 Investor5140 Reviews
    WebsiteView Page
    2Reply
  • JJ O.
    OP
    San Francisco, CA · Member since 2013 · 30 posts · 6 votes
    5y

    Thanks Dave for the cogent and compete explanation.  Your contribution to this forum helps so many!

    1Reply
  • Tina Peters
    Chico, CA · Member since 2016 · 18 posts · 4 votes
    5y

    @davefoster I am one of the type of investors that you mention is looking to 1031 into something more passive, at least with one SFR that I'm ready to move on. I keep getting told that I don't have options, other than buying more real estate. Reading your comments above, it sounds like there could be options. I'd like to learn what those options would be.

    1Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Tina Peters,  There are some pretty esoteric things that are considered to be real estate that qualify for 1031 treatment.  For instance, deeded time shares, boat slips and boat racks that have been condoed. .  Certain natural resource rights, and both working and royalty interests in oil, gas and minerals qualify.  There's actually quite a brisk trade from pure real estate into oil and gas and vice versa by a large class of investors

    The three most common moves into passive real estate investing are NNN commercial, Delaware Statutory Trusts, and tenants in common partnerships.

    NNN commercial property leases are generally guaranteed by the parent corporation leasing the property. And the tenant is responsible for all taxes, insurance, and maintenance.

    Tenants in common is simply buying real estate together with a partner or partners where each own part of the real estate itself.  A passive oriented person would want to partner with someone who like to manage and the relationship is structured accordingly.

    Delaware Statutory Trusts, although you own an interest in the trust itself, have been blessed by the IRS also as qualifying 1031 replacements.  Larger assets that are fully managed by a sponsor/manager.  You have no responsibilities other than going to the mail box to pick up your check (unless you have direct deposit).

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  • Jon Tedesco
    Charlotte, NC · Member since 2017 · 3 posts · 0 votes
    5y

    @Tina Peters hi Tina- I work with a few companies that offer Passive investing through DST. It allows 1031 into a 2B diversified REIT, deferred gains and guaranteed income. Let me know if you're interested in more info to see if a good fit.

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