[1031 exchange into TIC] Cost basis and Depreciation

[JJ O.]

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!

[Dave Foster]

@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.