Monday, August 08, 2005

3 Mistakes to Absolutely Avoid when doing a 1031 Exchange into to TIC

Have you ever wondered how an absolutely terrific concept can go so horribly wrong?
Don't you just hate to hear "I told you so" from your well-meaning friends and family?
Ever catch yourself saying "If only I'd have..."?
I'm one of those people who like to learn from someone else's mistakes. It saves me all kind of heartache and pain. If you're at all like me and have thought about doing a 1031 like-kind property exchange into a tenant in common (TIC) property, my bet is you'll be glad you did. If you can just avoid the 3 pitfalls that can make you wish you hadn't!
Before I let you in on the secrets, let me briefly explain exactly what a 1031 exchange into a tenant in common property is. It's a pretty well-kept secret in and of itself.
Those who benefit most greatly from this type of an exchange usually have several things in common.
1. They own investment property that has appreciated significantly in value.
2. They are tired of all the hassles of property management.
3. They don't want to pay huge amounts of capital gains tax if they sell.
4. They appreciate a significant increase in monthly passive income.
5. And, lastly, they still enjoy the relative stability of owning real estate.
Know of anyone who fits this description? If so, read on.
A 1031 exchange is when an investment property owner sells his current property and exchanges it for a "like-kind" property of equal or greater value. By doing so, he defers the payment of capital gains tax and the consequences of recaptured depreciation.
By exchanging into a tenant in common property, or a TIC, he becomes a part owner of a large commercial property managed by professionals who in turn pay him a monthly income. For those individuals described above, it can be a very valuable transaction. It often comes with fewer strings than private annuity or charitable remainder trusts, or an exchange into another property that needs their attention and drains their cash. I find that very few individuals, CPA's, attorneys, or even financial planners are well versed or knowledgeable in this area.
So what must you avoid at all costs when contemplating this exchange? The following three potentially disastrous scenarios.
First, do not deal with an investment company that does not have their act together. If they seem like they don't know what they are doing, run! Look into their history and prior offerings. Are the properties "A" grade commercial buildings, or something less desirable? Ideally, this should be their only business. Research the area where the new property is located. A local realtor or chamber of commerce can be very helpful in describing the area and the local economy. The property should already be almost fully occupied with quality tenants. If it was recently "refurbished" be sure to find out why that was necessary and what exactly was done. Be careful with Limited Partnerships when only one or two major players make all the decisions. Ask how they find the properties and what criteria they use to select them. Quality properties are hard to find and sell out quickly. Unless you have extensive experience in commercial property, don't get together a bunch of your friends and try and choose this property on your own. Ask yourself if you would like your office in that building, or see your doctor there, or shop in those stores. Remember in real estate the quality properties always remain more desirable, even when the mediocre properties start to lag.
Second, don't choose an Accommodator that has not done many, many of these transactions. This Qualified Intermediary is the one that makes sure all the documents and money transfers meet all the guidelines. He will set up your LLC. Your family attorney or estate planning attorney is most likely not your best choice. The last thing you want is the IRS sending you a hefty bill for taxes or penalties due to an incompetent or inexperienced Accommodator error.
Third, don't skimp on the property management company. They are extremely crucial to the property performance. You will be depending on them to handle the day to day problems that arise, carry the proper insurance, pay the property taxes on time, and keep your building fully occupied and in tip top shape. This company should offer you a long term triple net lease that has your annual income percentages spelled out, along with scheduled increases. There aren't many out there willing or able to do this. Ask to see their track record with other properties, and for a list of any judgments brought against them. Ask them if they've ever requested special assessments, or had any foreclosures. A good management company is worth its weight in gold. You want them to make a hefty profit, because their performance is directly related to your investment stability.
There you have it. I'm sure you've heard the saying "Penny wise and Pound Foolish". This is one time hiring the best will definitely bring you the most favorable results. It should truly be a win-win situation for everyone involved.
If you avoid the 3 major mistakes for the 1031 exchange into a tenant in common property, you will be the one saying "I told you so" as you collect your monthly check and watch your investment grow.
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