Q: My husband and I are selling a multi-unit property that we own with a couple of friends.
We want to defer the capital gain taxes. My husband and I have different plans for the cash than our friends, and it may wind up that we re-invest our share of the gain in a different property than they do.
Can we do this, or must the gain be re-invested into only one replacement rental property?
A: If you and your husband own your building as tenants in common with your friends, your sale should be pretty easy and you will be able to defer capital gains taxes and be able to purchase your own new investment property.
As tenants in common, you and your husband would own a specific share of the building. This share could be fifty percent or it could be any other percentage, but your title would specifically state that you own it as tenants in common or would state your specific percentage interest in the property.
Assuming you own fifty percent of the property, upon the sale of the property, you would have to set up an exchange trust under Section 1031 of the Internal Revenue Code. In simple language, there are companies that specialize in helping people defer taxes on commercial properties. These companies are generally referred to as qualified intermediaries. To defer the tax, the intermediary will have you complete a series of documents, including a 1031 Trust or Starker Trust.
The cost of setting up an exchange trust isn’t much but the benefits of deferring a significant amount of tax to the Federal government can be tremendous.
Things are a bit different if you own the property as joint tenants.
If you own the property as joint tenants, the presumption is that you both own the property in equal shares. If you and your husband invested in the property equally, you will both have to sell and distribute the proceeds from the sale equally.
If you actually own the property as joint tenants, but believe that you own a greater share than the other owners, you must discuss with your attorney a means to spit the ownership before the sale to allow you to defer your share of the profits properly.
At the closing, your share of any money from the sale of the property will go to the intermediary and you will have a certain number of days to identify the new property you want to buy and some additional number of days to close on the purchase of this new commercial property.
The rules regulating 1031 exchanges are rather strict. You must observe them or lose your ability to defer your taxes.
If your friends decide to keep the money and pay the tax, it shouldn’t affect your ability to set up an exchange. They can even set up their own for a separate property they may decide to buy.
In general, the new property’s price must exceed the price of the property you are selling. In your case, if you are a 50 percent owner of the old property, the new purchase price must exceed 50 percent of the old property’s selling price.
Keep in mind that you can’t receive any money from the sale of the old property. All of the money must be deposited with the exchange intermediary to be used for the purchase of the new property.
Finally, don’t forget that the new property must be a replacement investment property. You cannot use the funds to purchase a primary residence.
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