Prior to the new ruling, tax professionals were wary of fractional interests as replacement properties because the IRS might consider the investor's interest to be in a partnership, rather than in real property, effectively invalidating the exchange. (Section 1031 stipulates that shares of stock and partnership interests are not qualified property.)
In response to the need for high-quality replacement property in a range of prices, a niche group of companies began offering TIC interests to complete 1031 exchanges. To satisfy the title requirements, investors receive a deed for a percentage interest in the property, rather than a share of a partnership.
The new guidelines also open the door for investors who want to structure fractional interests in a desirable replacement property on their own, rather than through a sponsored program.
A summary of the New Guidelines Rev. Proc. 2002-22 provides guidance on the use of fractional interests as replacement properties in 1031 exchanges. Although the IRS did not provide safe harbor status for these investments, the ruling outlines 15 minimum standards that TIC interests must meet in order to be considered as potential replacement property. The highlights include:
- the number of tenants-in-common cannot exceed 35;
- the sponsor of the interests may own the property (or an interest therein) for only six months before 100 percent of the interests are sold;
- any decision that has material or economic impact on the property or to its owners must be approved unanimously by the owners; and
- any management agreements must be renewable annually and must provide for market rate compensation.
- For the complete listing of requirements, visit the IRS Web site at www.irs.gov. Investors should seek private letter rulings on specific offerings for more concrete assurance that a certain program qualifies under the ruling.
While TIC programs are in their infancy, tax professionals and other investment advisors should review any program being considered carefully. Because all programs are different and may have been structured before the release of Rev. Proc. 2002-22, careful due diligence is essential.
Whether for groups sponsoring fractional interests or creative investors looking to pool resources into a larger property, the new IRS guidelines are good news for the investors who want to enjoy the many benefits of a
1031 exchange.
About the Author
Ron Raitz, CCIM, is the president of Real Estate Exchange Services Inc. of Marietta, Ga. He serves on the board of directors of
the Federation of Exchange Accomodators (FEA). He may be reached at 770/579-1155, ext. 10 or by e-mail at
rees1031@mindspring.com.
February/ March 2003 VOL. 48, No. 2
