Selling the Farm

Back in the 1920s, Congress inserted an obscure provision into the United States tax code allowing individuals who were selling highly appreciated property to defer taxes by executing a “like-kind” exchange. The provision, designated a “1031 exchange”—named for the section of the code allowing it—was little noticed at the time.

Now, with thousands of farmers sitting on highly appreciated land, as well as other real estate skyrocketing in value, 1031 exchanges have become all the rage, with financial planners and brokers in the hunt for real estate that meets the requirements for such a transaction.

The real estate industry has responded. Buildings now are being sold to eager groups of investors looking, in turn, to sell Grandma’s farm—to the highest-bidding mall developer, say—and roll the profits into something that provides shelter from Uncle Sam and a source of income to boot. What those investors become is “tenant-in-common” owners of a portion of a qualifying parcel of commercial real estate, such as an office building, strip mall, or apartment building.

In a sense, a 1031 exchange is like an IRA rollover, only with real estate. Once the investor sells the property (Grandma’s farm, for instance), he or she can roll the money over, tax free, into a tenant-in-common investment handled by a “sponsor”—i.e., an investment firm that specializes in 1031 exchanges. Property that qualifies for a 1031 is broadly defined in the statute, from the investor’s point of view, to include anything but a person’s home—farms, raw land, any real estate asset. For the sponsor, it’s any commercial property—office, retail, or apartment buildings.

One of the most active 1031 exchange shops locally is the Minneapolis-based Geneva Organization. Since its founding in the latter part of 2003, Geneva has syndicated 36 properties for a total of more than $500 million in combined debt and equity. Dawn Campbell, Geneva’s senior vice president of sales, explains what 1031s are all about.

{Q} How does a tenant-in-common investment work?

TIC’ is a transaction in which instead of acquiring 100 percent ownership of the land and a building, someone will acquire an undivided interest as part of a group of investors in the same property. It’s direct ownership of the building, but they’re acquiring a portion of the property rather than 100 percent.

{Q} How is a TIC deal different from a conventional real estate limited partnership?

In a limited partnership, the general partner has complete control of the asset on behalf of the limited partner. With a TIC, you can’t have that because it wouldn’t qualify as ‘like kind’ under the 1031 rules. The legal and management agreements in a TIC specifically state that the asset cannot be sold unless all—or generally two-thirds—of the TIC owners agree. The owners also have to approve of any major changes to the asset.

{Q} Are there really that many people out there sitting on highly appreciated land or buildings?

Absolutely. The popularity of the 1031 exchanges started on the West Coast with California investors, because those properties were appreciating so rapidly. It has sort of moved across the country. I’ve been in this industry since 1991, and there has been a dramatic increase in the level of education among property owners.

{Q} How do I buy one of these investments?

You have to be an accredited investor, which means a net worth, including home and personal items, of $1 million or annual income of $200,000 singly, $300,000 jointly. You would have to be referred to Geneva through a financial planner or a broker-dealer. And, of course, you have to be selling highly appreciated real estate.