Bob Baradaran was quoted in an August 10, 2016, article by Law360 reporter Andrew McIntyre about the real estate boom in California (subs. req.) and the impact that boom is having on 1031 like-kind exchanges commonly used to avoid paying capital gains taxes on real estate sales. Pointing to the surge in prices in major metro real estate markets and the limited availability of new properties, investors are finding it challenging to find 1031 replacement properties and are looking at other avenues including tenant-in-common (“TICs”) and Delaware statutory trust structures. TICs and Delaware statutory trusts often comprise dozens of investors, and allow investors to buy pieces of properties as opposed to entire properties which can pose challenges in its own right.
“For example, if the market goes into a downturn and the investor needs to reposition the asset, it can be difficult if some of the other partners don’t understand the ins and outs of releasing, retenanting or refinancing,” said Baradaran.
“There are additional asset management headaches ... when they’re dealing with random unaffiliated third parties, who many times are not very sophisticated and who may become vocal and raise issues,” continued Baradaran. “It becomes very unwieldy. You have situations … where the program didn’t go exactly as identified. And sometimes [investors] even lawyer up and become adversarial with the sponsor."
Still, despite the challenges in setting up such structures, investors are increasingly looking to them.
While investors continue to look for ways to pass on tax liability to future properties, they also need to exercise caution, Baradaran said, and racing to do a like-kind exchange with the wrong property could lead to major problems.
Investors may save on taxes at the onset, but if they later have to sell the property for a steep loss, those savings and more can be quickly eroded.
“I actually think many investors make a mistake by getting into deals that are not the best deals to get into or appropriate for their risk profile, just to avoid the taxes,” Baradaran said.