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October 31, 2011

When taxes motivate a transaction, know the consequences.

Provisions in the tax laws are intended to stimulate, encourage, etc. certain expenditures.  These used to be called “tax shelters”.  “Loopholes” used to be benefits that were not intended by the tax laws.  Today everything that reduces taxes are referred to as “loopholes”.
My first look at tax motivated expenditures was as a field agent for the Internal Revenue Service (IRS).  I audited individuals and businesses that promoted the tax shelters and individuals and businesses that purchased them anticipating increased returns.
When I entered public accounting, I also dealt withindividuals and businesses that promoted the tax shelters and individuals and businesses that purchased them.  It quickly became obvious that many on both sides did not understand the requirements, costs, limitations and risks involved with these expenditures.  The high commissions and other incentives to the promoters provided a strong incentive to sell these investments.  The tax benefits was a strong incentive to purchase the investments.  Getting out of these investment was much more difficult than getting into them.   
Jaon Zweig’ s October 29th article discussed a specific tax strategy that helped qualify real estate transaction for tax deferrals.  Real estate owners that wanted to dispose of a property and invest the proceed in another property are able to defer the taxation of any gain by entering into a like-kind exchanges (1031 exchange).  Frequently there were logistic, financial, and other issues that prevent the property owner to have a like-kind exchange.  Some times the real estate owners wanted to do estate planning, succession planning or resolve management issues. These issues and goals were resolved using an investment vehicle called tenancies-in-common (TIC).
Promoters started offering TICs to everyone.  Many people that purchased them did not get the benefits they were looking for and/or had problems and expenditures they did not anticipate.
If you are considering an expenditure because of the tax advantages consult your advisers.  Make sure that you know what you are getting and that you understand the consequences of the transaction.

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