TAX-DEFERRED EXCHANGES Presented by Michael G Hill MBA

TAX-DEFERRED EXCHANGES Presented by: Michael G. Hill, MBA, CEP, IAR President/Branch Manager

• There are significant risks associated with 1031 Tenant In Common (TIC) investments and are not suitable for all investors. • TIC interests are illiquid. • This material does not constitute an offer to buy or sell any security. • The information contained in this material should not be deemed as legal or tax advice. Be sure to consult with your tax and legal advisors. Securities offered through Berthel Fisher & Company Financial Services, Inc. (BFCFS) Member FINRA/SIPC. Hill and Associates is independent of BFCFS 660 N. Central Expy # 102 Plano, TX 75074 800. 333. 3030 972. 509. 8855

What is a 1031 Exchange? • Section 1031 of the IRS tax code allows property owners to sell one or more of their properties and exchange with one or more “like-kind” replacement properties. • The tax code enables a taxpayer to sell investment property with little or no tax liability on any resulting gain – preserving the sale proceeds for the purchase of another property.

Benefits of a 1031 Exchange • Ability to defer capital gains tax. • Preservation of asset value increases “earning power”. • Diversification potential across multiple properties. • Eliminate day to day management responsibilities.

Risks of a 1031 Exchange • TIC interests are not diversified so investors are more exposed to risk of decline in real estate values. • Cash flow generated from TIC investments is not guaranteed. • There are substantial costs associated with a 1031 investment and can offset the benefits of an exchange. • Changes in the IRS 1031 tax code could impact future 1031/TIC exchanges.

Revenue Procedure 2002 -22 • Prior to 2002 the IRS had not formally adopted a Tenants-in-Common, (TIC) structure as being sufficient to satisfy the code requirements under section 1031. • Rev. Proc. 2002 -22 outlined 15 points that the offering should meet in order to be considered an undivided interest in real property rather than an interest in a business entity for federal tax purposes.

The Fifteen Points 1. Each of the co-owners underlying TIC interest must hold title to the property as a tenant-in-common under local law. It can not be held as a business entity. 2. The co-owners may not file a partnership or corporate tax return, conduct business under a common name, execute any agreement that identifies any or all of the co-owners as partners, shareholders, etc. or otherwise hold themselves out as a partnership or business entity. 3. The number of co-owners can not exceed 35 persons. (Husband wives are generally considered one person).

The Fifteen Points 4. The co-owners may enter into a limited co-ownership agreement that may run with the land. The agreement must allow for co-owners to offer a co-ownership interest to the other co-owners, the sponsor, (a sponsor is a person that divides a single interest into multiple coownership interests in order to offer the interests for sale to others), or a lessee of the property at the fair market value of the interest at the time of any partition. 5. The co-owners must retain certain rights. Key among them; the right to approve the hiring of any manager, sale or disposition of the property, any and all leases, (including renewals), or creation or modification of any blanket liens. These issues must be approved unanimously by all of the co-owners. Any other actions by the co-owners or on their behalf must be approved by a vote of those holding more than 50% of the undivided interests.

The Fifteen Points 6. Each co-owner must generally have the right to transfer, partition, or encumber their interest without the approval of any other person. However, this right may be limited in the event of requirements by any lender as is customary in normal lending practices. Co-owners, sponsors, lessees also may have the “right of first offer” before the transfer is exercised. 7. When the property is sold any debt securing the property must be paid first and any remaining proceeds distributed to the co-owners in proportion to their pro-rata share of ownership. 8. Co-owners must share in all revenue generated or costs associated with the property pro rata to their ownership interest. Any money loaned or advanced to any co-owner must be recoursed to that owner and repaid no later than 31 days from receipt.

The Fifteen Points 9. If debt is placed on the property, each co-owner must share pro rata in the same percentage as their undivided equity interest in the property. 10. Call options may be issued, but must have an exercise price that equals then fair market value of the interest. Put options are never allowed. 11. With respect to the property, any co-owner may only perform services at the property which are considered to be customary services in connection with maintenance, etc. Example: A co-owner could not set up a valet parking business for his benefit in front of the property. 12. Co-owners may enter into property management agreements and brokerage agreements with anyone other than a lessee. These agreements must be renewable at least annually and must be approved by a unanimous vote of the co-owners.

The Fifteen Points 13. All lease agreements must be bona fide lease agreements as described for federal tax purposes. The rents must reflect current fair market value. 14. Any debt placed on the property can not be secured with any lender that is related to the sponsor, a co-owner, manager, or any lessee. 15. Any fees, commissions, or costs for services paid to the sponsor or affiliates must reflect the fair market value of such remuneration and can not be based on any income or profits derived from the property.

TIC’s & the Securities World • The SEC has stated that a Tenants-in-Common offering is an investment contract and as such is deemed to be a security. • Representatives must have an FINRA Series 7 or 22, and be registered with the FINRA, SEC, and the states in which they wish to do business, as well as being affiliated with a registered Broker / Dealer, before working with and making an offer to sell to any investor. • For tax purposes a TIC offering is deemed to be real estate and not a security as described in section 1031 of the code.

The 1031 Process 1. Seller arranges for sale of property and includes exchange language in contract. 2. At closing, proceeds go directly to the Qualified Intermediary*. 3. Seller identifies potential exchange properties within 45 days of closing. 4. Seller completes 1031 Exchange within 180 days of closing. *Qualified Intermediary is a person or entity that can legally hold funds to facilitate a Section 1031 Exchange. To be qualified, the intermediary must not be a relative or agent of the exchanging party.

The 1031 Process Exchanger Step 1 Step 6 Transfers Existing Property Acquires New Property Step 2 Step 5 Receives Existing Property New Property Transferred to Qualified Intermediary Buyer Of Existing Property Seller Qualified Intermediary Of New Property Step 3 Step 4 Funds Held In Escrow Funds Used To Purchase New Property

Regulation D • TIC offerings are sold under the Regulation D exemption to registration with the SEC. – Sect. 501: Accredited Investors. Net worth or joint net worth with a spouse of $1 mil at the time of purchase; or an individual with income exceeding $200, 000 in the last two years or joint income with a spouse exceeding $300, 000 for those years and a reasonable expectation of the same in the current year; or a trust with assets in excess of $5 mil, not formed to acquire the securities offered. – Sect. 502(c): General Solicitation. There can be no general solicitation of clients. No advertising, cold calling, etc. Offerings can not be made to the general public since all investors must be “accredited”. – Sect. 506: Offers and Sales Without Regard to Dollar Amount. To qualify for 506, no restriction on the amount of dollars raised, offering must meet requirements of 501 + 502 above.

Documentation Offering Solicitation Period • • • All offerings come in the form of an Offering Memorandum or a Private Placement Memorandum, (PPM). No offering can be solicited without a PPM will include, but not be limited to; Risk Factors, Description of Property, Summary of Offering, Acquisition and Financing disclosure, Projections of Cash Flow, management team disclosure, legal opinion, etc. A client needs to complete a Purchaser Questionnaire and Subscription Agreement, (a good faith deposit is generally required by the sponsor at this time).

Documentation Closing Documents • Tenants-in-Common Agreement – Terms and conditions between investors, (TIC’s). • Property Management Agreement – Terms between TIC’s and Property Manager. • Asset Management Agreement – Terms between TIC’s and Asset Manager. • Loan Agreement – Terms of the loan. • LLC – Sponsor will form a separate Special Purpose Entity (SPE) for each investor. • Title documents, deed, etc. • Additional documents as necessary, (Master Lease, Leasing Parameters, Trust Agreement, etc. ). • Investor will need to open an independent bank account in the name of the SPE for deposit of monthly / quarterly income checks.

Closing • • • Investor will notify Qualified Intermediary or Accommodator as to which offerings are to be used for identification purposes. Upon receipt of Purchaser Questionnaire and Subscription Agreement by Sponsor from Investor, Sponsor will coordinate closing and title transfer with QI. Upon closing, Sponsor will provide Investor with a complete set of closing documents for their files.