2018 Fall Newsletter

What’s New:

I have just returned from my annual Federation of Exchange Accommodators 1031 conference. The conference had a lot of daily transactional information to assist Qualified Intermediaries in improving their documentation and knowledge, as well as the latest tax and economic updates that affect the real estate and 1031 exchange industry. 

As you know, the largest change to the 1031 industry was the elimination of personal property exchanges. QIs who solely handled personal property exchanges have had to reinvent themselves in order to stay in business. The FEA continues to be the strongest voice in Washington to educate legislators on the benefits of and reasons for keeping Section 1031 of the Internal Revenue Code. When you have an opportunity, please be sure to let your legislator know that you support keeping 1031 exchanges.

One topic of discussion that we don’t often see in our area, was the variety of alternatives to the traditional replacement property available to the taxpayer. Below is a short statement on some viable alternatives for your clients who are having a difficult time finding a suitable replacement property in this time of low inventory.

1. Tenants-In-Common (TIC). Commercial real estate professionals commonly refer to these fractional ownership opportunities as tenancy-in-common interests (or TICs). These have been around since the 1990s, but were officially recognized and sanctioned by the IRS in 2002. These types of exchanges allow up to 35 investors to share ownership in a like-kind exchange replacement property. As each investor holds ownership, each has voting rights on decisions concerning the property. Major decisions such as contract renewal or selling of the property require unanimous approval of the co-owners, which can be difficult to obtain. While not a specifically stated IRC requirement, nearly all TIC exchanges stipulate that investors set up a single-member LLC, which is considered a “disregarded entity,” exempting them from the “same taxpayer rule” that requires continuity of title on the property.

Tenancy-in-common interests offer increased opportunities to identify a replacement property within 45 days, the option to buy into institutional-grade product for less money, and the potential to diversify into multiple properties with fewer dollars. While the IRS did not provide a complete safe harbor blessing for these investments, it outlined 15 minimum standards TICs must meet to be considered as potential replacement property. For the complete listing of requirements, visit the IRS Web site at http://www.irs.gov/. Investors should seek private-letter rulings on specific offerings for more concrete assurance that their fractional interest meets the specified qualifications.

2. Delaware Statutory Trust (DST). In 2004, the IRS approved a second method for investors to exchange into co-ownership of properties. The DST structure was developed to overcome some of the weaknesses of TIC exchanges. DSTs are a good solution for those investors who are looking for a more passive investment. DSTs are a fractional ownership in an individual or portfolio of large commercial or residential properties. DSTs can be a good solution when you cannot find suitable replacement property as you near the end of your 45-Day Identification Period or you have bought your desired replacement property and still have some additional exchange funds to spend.

Instead of sharing ownership of a property, investors buy into a trust that holds title while the sponsor manages the property. While this offers less control to investors, it removes the challenges faced in many TIC properties. In a DST there is no need to achieve consensus, which means that one disagreeable investor cannot hold up important decisions. The lack of direct ownership also means that investors already have limited liability and therefore do not need to set up individual LLCs in their names.

3. Umbrella Partnership Real Estate Investment Trust (UpREIT). This type of investment can provide virtually the same tax-deferred benefits to real estate investors that a 1031 Exchange provides when they contribute their investment real property into a new ownership structure that includes an operating partnership with a REIT.  Investors can effectively dispose of real estate and acquire an interest in a REIT on a tax-deferred basis by taking advantage of the upREIT strategy. 

UPREITs are generally structured as a two-step process using a combination of a tax-deferred exchange pursuant to Section 1031 of the Internal Revenue Code ("1031 Exchange") and subsequently a tax-deferred contribution of real estate into a partnership pursuant to Section 721 of the Internal Revenue Code ("721 Exchange"). 

The first step is selling the relinquished property and structuring a 1031 Exchange.  The investor would identify and acquire a fractional interest (tenant-in-common interest) in real estate that the REIT has already designated.  This completes the 1031 Exchange portion of the transaction. The second step is to contribute the fractional interest into the operating partnership after a holding period of 12 to 24 months as part of a 721 Exchange.  The investor receives an interest in the operating partnership in exchange for his or her contribution of the real estate and is now effectively part of the REIT.

4. Oil and Gas Royalties. Oil and gas royalty investment began in the early 1900s. The owners of such assets receive monthly payments from oil and gas companies who drill and operate wells on their property (if such wells are producing). Over the past four decades, courts have re-affirmed that oil and gas royalty interest qualifies as “like-kind” to all other forms of real property. In addition, there are several Revenue Rulings and Private Letter Rulings which have established the like-kind nature of royalties when exchanging out of traditional real estate.

This information is for educational purposes only and not to be construed as or relied upon as tax or legal advice. Please ensure you consult your tax professional relative to any of the above-cited options.

Market News:

• According to the National Association of Realtors, single women account for 17% of homebuyers—more than twice the percentage of single men. Married couples make up the largest share of homebuyers at 65%, with single females at 18% and single men at 7%. And, interestingly, the largest percentage of single female buyers is in the 72 and older age group.

• 2017 was a milestone year for the FBI’s Internet Crime Complaint Center (IC3), which was established in May of 2000. On October 12, 2017, the IC3 received its 4 millionth consumer internet crime complaint.

2019—Predicting the future of real estate.

It’s never too early to start attempting to predict what will happen with the market in 2019. Four predictions I have seen for 2019:

1. Increase in new-home construction.

2. Most markets will continue to still favor sellers over buyers.

Inventory shortages affected many housing markets across the country during 2017 and 2018. And this will likely continue, to some extent, in 2019 as well. Most cities are experiencing low levels of inventory at present. The tightest markets are in the west — California, Washington, and Oregon. But, nearly every state is touched by this.

3. Mortgage rates could approach 5%, for a 30-year loan.

4. Home prices will continue rising in most U.S. cities.

Legal News and Case Law:

1031 Drop & Swap—Taxpayer won!

In the Appeal of Sharon Mitchell, the taxpayer had a 10% interest in a general partnership along with 15 other partners. The purchase agreement was signed by the general partnership in 2007. In November of that year, the general partnership signed a redemption agreement then executed a deed for a 10% tenancy in common to the taxpayer. The taxpayer then signed a deed to the buyer for the 10% interest and it was recorded. The Federal Tax Bureau (FTB) argued that the general partnership and not the individual taxpayer was the seller of the property. However, the Office of Tax Appeals found for the taxpayer since she was continuing investment in real property, not cashing out and a last-minute change in ownership form did not matter. Further, the opinion did not focus on the nature of a general partnership versus a limited liability company, so it may very well apply to those as well. The decision is currently being appealed by the FTB.

REMINDER: Recording of Trust documents and Death Certificates. 

Just a reminder that effective September 18,2 018, you must record a Death Certificate and Certificate of Trust separately, and not as an attachment to a document:

• PA 194 of 2018 amended Public Act 133 of 1991 (MCL 565.434) to require that a trust agreement or certificate of trust existence and authority that accompanies an instrument that affects an interest in real property be recorded as a separate document.
   
• PA 195 of 2018 amends MCL 565.48, which governs the conveyance of real property by a surviving joint tenant or tenant by the entirety, to require a death certificate to be recorded as a separate document when it is being filed concurrently with the deed or other instrument that purported to convey an interest in land by the survivor or survivors. 

Corporate Settlement Solutions has many Michigan branch offices to serve you—Traverse City, Suttons Bay, Elk Rapids, Charlevoix, Bellaire, Mt. Pleasant, and Big Rapids in addition to providing services throughout the eastern United States.

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