How does an IRS 1031 Tax-Deferred Exchange Work?

To accomplish an exchange, the seller ("exchanger") deposits all of the proceeds from the sale of real property (known as a "relinquished property") into a special holding account designated for purposes of consummating a tax-deferred exchange. These holding accounts are normally controlled by Qualified Intermediaries (known as QI's or Exchange Accommodators) or other financial institutions.

The Exchanger has a maximum of 180 calendar days from the closing of the sale of the relinquished property to complete the acquisition of the new property (known as the "replacement property"). Within the first 45 days of this period, the Exchanger must designate and properly identify one or more replacement properties. There are a few different methods for identifying properties. An exchanger should consult their QI regarding this issue. (Attach link to ERI)

The funds deposited into the holding account can be used as earnest money for the replacement property once all IRS requirements for a ¤1031 transaction have been satisfied. If no replacement properties are identified in the first 45 days, or if the acquisition of the replacement property occurs more than 180 days following the sale of the relinquished property, the funds held in the holding account will be disbursed, the funds will be returned to the Exchanger and the sale of the relinquished property will be taxed at the prevailing capital gains and/or ordinary tax rates.

How do TIC and DST Structured Programs Benefit a 1031 Exchange Investor?

• They provide investors with properties designed to defer their capital gains tax.
• They help investors who are in their 45 day identification period find reliable replacement property
• They can be used as a back up option in case their primary replacement property does not close.
• They are designed to meet the debt and equity requirements of an exchange
• They provide investors with the opportunity to diversify their portfolio into higher quality "institutional type" real estate
• They allow investors to take a passive ownership/management role
• They are structured to provide investors with immediate cash flow from the properties rental income.
• They have a defined exit strategy. Holding periods range from 5-10 years. Actual holding periods may be longer or shorter depending on property specific factors.

Who are the Major Participants in a 1031 TIC/DST Transaction?

• The TIC or DST Sponsor.
• Sponsors are entities, typically experienced real estate investment companies that specialize in fractional ownership programs. TIC/DST Sponsors acquire or assist investors with the acquisition of their replacement property. Sponsors will conduct due diligence, arrange financing, raise equity (using the services of Broker-Dealers and their Registered Representatives), manage the property (either internally or by hiring a third party), provide asset management services and sell the asset all on behalf of their investors.
• A Qualified Intermediary (QI)
• The intermediary (or middleman) is required to hold, in a segregated holding account, the sales proceeds realized by the exchanger from the sale of relinquished property. The QI retains the proceeds until the earlier of the date the exchanger is prepared to close the acquisition or the replacement property and the expiration of either the 45-day identification period or the 180-day closing period.
• A Broker-Dealer and Registered Representative
• Broker-Dealers are companies licensed to sell securities to investors. Broker Dealers are typically registered with the Securities Exchange Commission and the National Association of Securities Dealers or other regulatory bodies. Registered Representatives (often called Registered Reps or Reps) are licensed salespeople employed by or affiliated with the Broker-Dealers.
• Registered Reps work closely with investor's in an attempt to help them locate suitable TIC or DST properties. A good Representative will provide their investor with valuable information and commentary on each property and help the investor find a program that is closely aligned with their desired property type, location, expected return and risk tolerance.
• The Exchanger
• An individual or entity that uses their exchange proceeds to purchase a fractional interest in a TIC or DST program.

What Types of Properties are Syndicated for TIC and DST Programs?
Properties typically syndicated for these types of programs fall into the class of institutional quality real estate. Their valuations range from $10- $150 million in acquisition price. Investors working with brokerage firms that provide a broad range of sponsors will typically have the opportunity to invest in office, retail, industrial, multi-family, student housing and hospitality oriented properties.

Where are the Properties Located?
TIC/DST properties are located throughout the United States and can provide investors with valuable geographic diversification in their portfolio.

How Many Investors are allowed in any one Program?
Tenant in Common (TIC) Programs fall under Revenue Procedure 2002-22 which states that TICs can have no more than 35 investors. On average, TIC programs will be acquired by 20 to 25 investors. TIC programs tend to have higher minimum investment amounts because the investment group is small compared to DST offerings.

Delaware Statutory Trust (DST) Programs fall under Revenue Ruling 2004-86 which states that DSTs can have up to 99 investors in any one program. The DST structure will allow for lower minimum investments because more investors are allowed to participate.

What are the Investment Minimums? Equity Investment Minimums will range from $100,000 to $1,500,000.

Who May Invest?
Both TIC and DST programs are limited to "accredited" investors only. Note the following requirements:

• Individual investors must have a net worth of $1,000,000 or more (inclusive of your home, rental property(s), retirement accounts, etc.)
• In lieu of a $1,000,000 net worth, an individual must have income in excess of $200,000 or more in 2 of the most recent 3 tax years. ($300,000 if married and filing jointly.)
• Irrevocable Trusts must have a net worth of $5,000,000 or more.

Are there any Tax Benefits with these Types of Programs?
There are several tax benefits:

• Depreciation- A portion of the income from rents will be sheltered due to the depreciation of the property.
• Capital Gains Tax Deferral- These programs are structure to provide investors with the ability to exchange into and out of a DST or TIC program.
• Estate Planning Tool- Heirs will receive a step-up in cost basis. In other words, the value of the property at the date of death will be the new basis for which any future capital gains tax will be calculated.
• Discounting- The value of your interest may be discounted for tax purposes based on the level of control.

What are the Risks Associated with TIC and DST Investment Properties?

• Leasing Risk- Tenants may vacate the space and there can be no assurance that new tenants can be found in a timely manner
• Market Risk- Real estate values fluctuate and there is no assurance against loss in the future.
• Liquidity Risk- There is no secondary market to sell your interests and there is no assurance that a property can be sold in a timely manner.
• Management Risk- Investors will rely on the expertise of the property manager
• Lack of Control- Investors will give up a certain level of control with these types of programs
• Interest Rate Risk- A rise in interest rates could negatively affect cash flow and property values
• Exchange Risk- the IRS could disallow an exchange if the structure is deemed to be a partnership and not a fractional ownership.
• Capital Call- If cash flow and reserve amounts are not enough to cover capital expenditures, investors may have to make additional contributions into the property

What is Non-Recourse Financing?
Non-Recourse Financing is a type of lending where the lender assumes complete responsibility for the collection of debt. If the debt is not collected due to the financial inability of the customer, the lender assumes the loss. In most cases, the lender will have certain carve outs to protect themselves against fraud, voluntary bankruptcy, or violation of certain provisions.

This type of financing is preferred by most individuals and entities as the lender can not attach themselves to other assets as a result of a default on the loan. This protects the investor from loss beyond their investment in the property.

Can I Sell My Interests Prior to the Property Being Sold? Most programs provide investors with the ability to offer their interests for sale or transfer. Typically, the Lender will require prior approval and investors will usually be required to offer the sale of their interest first to the other TIC or DST investor's.

It is important to note that there is no secondary market available for use in selling TIC/DST interests. Interests in these programs are considered illiquid and there can be no assurance that your interests can be sold in a timely manner or at all.

Important Disclosure...
Information contained in this FAQ area does not, under any circumstances, constitute tax or legal advice. This summary of frequently asked questions and the answers to the questions posed have been provided as general information only. Midpoint Financial Services highly recommends that each individual investor retain the services of a highly qualified exchange accommodator for answers to IRC ¤1031. MFS also recommends that each individual investor retain the services of their own independent tax, legal and business advisors prior to investing in any securities offerings including those offered by Midpoint Financial Services, Inc.