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Inland Private Capital Corporation
1031 Exchange Solutions II: Fractional Investments
and Private Placements
A Presentation for Certified Public Accountants
Disclaimers
• Investments are suitable for accredited investors only.
• This material is neither an offer to sell, nor the solicitation of an
offer to buy any security in any program sponsored by Inland
Private Capital Corporation (“IPCC”), which can be made only
by the Private Placement Memorandum (“PPM”), and sold only
by broker dealers authorized to do so. Any representation to
the contrary is unlawful.
• This is a brief and general description of certain 1031
guidelines. Because each investor’s tax implications are
different, prospective investors should consult with their
own tax advisors regarding an investment in the Interests.
• The photographs shown are properties that are owned by
IPCC-sponsored programs that have closed offerings.
• The companies depicted in the photographs herein may have
proprietary interests in their trade names and trademarks.
Nothing herein shall be considered to be an endorsement,
authorization or approval of IPCC, or the investment vehicles it
may offer, by the aforementioned companies. Further, none of
the aforementioned companies are affiliated with IPCC in any
manner.
• The Inland name and logo are registered trademarks being
used under license. This material has been distributed
by Inland Securities Corporation, placement agent for Inland
Private Capital Corporation. Inland Securities Corporation,
member FINRA/SIPC.
• Date of first publication: 3/2016
1
Risk Factors
• Interests in an IPCC-sponsored program may be sold only to accredited
investors, which for natural persons, are investors who meet certain minimum
annual income or net worth thresholds.
• Interests in an IPCC-sponsored program are offered in reliance on an exemption
from the registration requirements of the Securities Act of 1933, as amended,
and are not required to comply with specific disclosure requirements that apply
to registration under the Securities Act of 1933, as amended.
• The Securities and Exchange Commission has not passed upon the merits of or
given its approval to the interests in any IPCC-sponsored program, the terms of
any offering, or the accuracy or completeness of any offering materials.
• No public market currently exists, and one may never exist, for
the interests of any IPCC-sponsored program. The purchase
of interests in any IPCC-sponsored program is suitable only for persons who
have no need for liquidity in their investment and
who can afford to lose their entire investment.
• IPCC-sponsored programs offer and sell interests pursuant
to exemptions from the registration provisions of federal and
state law and, accordingly, those interests are subject to
restrictions on transfer.
• Investors should not assume they will be able to resell their interests.
• There is no guarantee that the investment objectives of any particular IPCC-
sponsored program will be achieved.
• The actual amount and timing of distributions paid by IPCC-sponsored programs
is not guaranteed and may vary. There is no guarantee that investors will
receive distributions or a return of their capital.
• Investments in real estate are subject to varying degrees of risk, including,
among other things, local conditions such as an oversupply of space or reduced
demand for properties, an inability to collect rent, vacancies, inflation and other
increases in operating costs, adverse changes in laws and regulations
applicable to owners of real estate and changing market demographics.
• Investors should be able to bear the loss of their investment.
• IPCC-sponsored programs depend on tenants for their revenue, and
may suffer adverse consequences as a result of any financial
difficulties, bankruptcy or insolvency of their tenants.
• IPCC-sponsored programs may own single-tenant properties, which
may be difficult to re-lease upon tenant defaults or early lease
terminations.
• Continued disruptions in the financial markets and challenging
economic conditions could adversely affect the ability of an IPCC-
sponsored program to secure debt financing on attractive terms and
its ability to service that indebtedness.
• The prior performance of other programs sponsored by IPCC should
not be used to predict the results of future programs.
• The IPCC-sponsored programs do not have arm’s length agreements
with their management entities.
• The IPCC-sponsored programs pay significant commissions and fees
to affiliates of IPCC, which may affect the amount of income investors
earn on their investment.
• Persons performing services for the managers of the IPCC-sponsored
programs perform services for other IPCC-sponsored programs, and
will face competing demands for their time and service.
• The acquisition of interests in an IPCC-sponsored program may not
qualify under Section 1031 of the Internal Revenue Code of 1986, as
amended (the “Code”) for tax-deferred exchange treatment.
• Changes in tax laws may occur, and may adversely affect an
investor’s ability to defer capital gains tax and may result in immediate
penalties.
• The DST structure is inflexible and, in certain events, may be
converted to a LLC structure, which would have a tax impact on
investors.
2
What is a 1031 Exchange?
• Section 1031 of the Code provides an alternative
strategy for deferring the capital gains tax that may
arise from an investor’s business/investment
property sale.
• By exchanging the property for like-kind
real estate as defined on the following slide,
property owners may defer their Federal taxes and
use all of the proceeds for the purchase of
replacement property.
• Whether any particular transaction will qualify under
Section 1031 depends on the specific facts
involved, including, without limitation, the nature
and use of the relinquished property and the
method of its disposition, the use of a qualified
intermediary and a qualified exchange escrow,
as discussed in more detail on the following slides,
and the lapse of time between the sale
of the relinquished property and the identification
and acquisition of the replacement property.
Orlando Student Housing – The Retreat 3
What is “Like Kind?”
Wholly Owned Assets
• Vacant land
• Commercial rental property
• Commercial property
• Industrial property
• 30-year or more leasehold interest
• Farm property
• Residential rental property
• Doctor’s own office
Fractional Interests
• Beneficial Interest in a Delaware Statutory Trust
(DST)
• Tenant in Common interest in investment property
Both the relinquished and the replacement properties
must have been held for investment purposes or for
productive use in a trade or business.
Whole Foods Market – Park Ridge, IL 4
Key 1031 Guidelines to Remember
• Seller cannot receive or control the net sale proceeds – the proceeds must be deposited with a
Qualified Intermediary.
• Replacement property must be like-kind to the relinquished property.
• The replacement property must be identified within 45 days from the sale of the original
property.
• The replacement property must be acquired within 180 days from the sale of the original
property.
• The cash invested in the replacement property must be equal to or greater than the cash
received from the sale of the relinquished property.
• The debt placed or assumed on the replacement property must be equal to or greater than
the debt received from the relinquished property.
5
This is a summary of some of the key guidelines for a transaction under Section 1031, but this is not an exhaustive list. The costs associated with a
1031 exchange may impact an investor’s returns and may outweigh the tax benefits of the transaction. Each prospective investor must consult his or
her own tax advisor regarding the qualification of a particular transaction under Section 1031.
What is a Qualified Intermediary?
• The Qualified Intermediary (“QI”) is a company that is in the full-time business of
facilitating Section 1031 tax-deferred exchanges. The role of a QI is defined in
Treasury Regulations.
• The QI enters into a written agreement with the taxpayer where QI transfers the
relinquished property to the buyer, and transfers the replacement property to the
taxpayer pursuant to an exchange agreement.
• The QI holds the proceeds from the sale of the relinquished property in a trust or
escrow account in order to ensure the taxpayer never has actual or constructive
receipt of the sale proceeds.
• The identification and replacement timelines should be monitored by the QI and the
identification is done through the QI.
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Replacement Property Identification
• Done through the QI
• Unambiguous, specific, written identification made and signed by Exchanger
• Three-property rule, 200% rule or 95% exemption are options
• Can be changed, in writing, before the end of the 45 days
• If property closes before the 45th day, no identification is necessary
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Three Ways to Identify
• Three Property Rule: The exchanger may identify as potential replacement
property any three properties, without regard to their fair market value.
• 200% Rule: The exchanger may identify any number of properties, provided the
aggregate fair market value of all of the properties does not exceed 200% of the
aggregate fair market value of all of the relinquished properties.
• 95% Exception: If the exchanger identifies more potential replacement properties
than allowed under either the Three Property or the 200% Rules, the exchanger will
be treated as if no replacement property was identified unless they actually receive
replacement property worth at least 95% of the aggregate fair market value of all of
the identified replacement properties.
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• Property held in trust dates back to 16th century English common law.
• Trust ownership formally recognized in the US in 1988.
• Working with the Internal Revenue Service, IPCC’s then counsel, Jenner &
Block, worked with the Treasury Department to facilitate their
understanding of the Delaware Statutory Trust.
• Revenue Ruling 2004-86 was issued as a result of that collaboration.
• RR 2004-86 defined the DST as a Fixed Investment Trust, with a series of
attributes that could not be changed once the Trust was established.
• A properly created DST would then be considered “like-kind” real estate in
a Section 1031 exchange.
History of the Delaware Statutory Trust (DST)
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DST Benefits
• 1031 Exchange in/out
• Passive investments
• No financials or loan guarantees from investors
• Institutional quality properties
• Professional management
• Low minimum investment - $25,000
• Quick close
• Fills gaps to realize maximum tax deferral benefits
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Please also note that there are certain risks related to the DST structure, including the risk that investors
have limited control over the DST.
The DST
• Special purpose entity that is bankruptcy remote
• Passive holder of real estate
• Types of Assets:
o Long-term triple net lease to credit tenant
• Tenants are responsible for all property expenses
o Master Lease to an affiliate of the sponsor (a “Master Tenant”) that operates the real
estate
• Reserves are established to cover projected expenses over holding period
• A DST may own one or more properties.
• The rights and obligations of investors in a DST will be governed by the DST’s trust
agreement.
• Investors have limited voting rights over the operation and ownership of any properties
owned by the DST.
• The trustees of the DST will be entitled to certain fees and reimbursements, as set forth
in the applicable trust agreement.
• Multiple Investors in each property with the percentage of beneficial ownership varying
from one investor to the next.
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Often used in multiple-owner, securitized programs, benefits of the DST structure exist
for both the exchanger and, if a property is financed, the lender. Among these benefits
are the following:
• The lender makes only one loan to one borrower (the DST).
• The trust agreement is written to prevent creditors of the exchanger from reaching
the DST’s property, therefore making it bankruptcy remote.
• The DST shields the exchanger from any liabilities with respect to the property.
• Exchangers have no operational control over the management of the DST or its
property.
• Because exchangers have no operational control over the DST, the lender has no
need to perform due diligence or obtain financial information on individual
exchangers.
• Because exchangers have no operational control over the DST, exchangers should
also not be required to sign any indemnifications or guarantees.
• 1031 Exchange treatment subject to “Seven Deadly Sins”.
Understanding the DST
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1. Once the offering is closed, there can be no future equity contribution to the
DST by any co-investors or beneficiaries.
2. The Trustee of the DST cannot renegotiate the terms of the existing loans, nor
can it borrow any new funds.
3. The Trustee cannot reinvest the proceeds from the sale of its assets.
4. The Trustee is limited to making capital expenditures with respect to the
property to those for (a) normal repair and maintenance, (b) minor non-
structural capital improvements, and (c) those required by law.
5. Any liquid cash held in the DST between distribution dates can only be
invested in short-term debt obligations.
6. All cash, other than necessary reserves, must be distributed to the investors
or beneficiaries on a current basis.
7. The Trustee cannot enter into new leases or renegotiate the current leases.
The “Seven Deadly Sins”
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Mitigation of the “Seven Deadly Sins”
• Acquire new or recently rehabbed properties
• Provide for substantial reserves in the offering
• Carry adequate insurance
• Have financing terms that are shorter than the term of the agreement between the DST and the Tenant
• Sell the property prior to loan maturity
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Springing LLC
• If loan is in actual or imminent default due to tenant bankruptcy or insolvency, no
need to spring
• Situations where springing may occur
o Unable to refinance debt
o Loss of tenant (goes dark)
o Change of tenant structure (bought out by another company, taken private)
• Tax consequences of converting to an LLC
o Treated as a partnership – no future Section 1031 exchanges (generally)
o Original Section 1031 transaction not affected
o Potential ability to convert back to DST to do a subsequent Section 1031
exchange
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If the Trustee of the DST determines that the DST is in danger of losing the
mortgaged property due to tax related restrictions on the Trustee’s ability to act, it can
convert the DST into an LLC, with a lender-approved operating agreement.
DST
• Governed by Revenue Ruling
2004-86
• Trust owns 100% of the real
estate
• One loan made to the Trust
• Investor does not sign any
guarantees
• Lender does not underwrite each
investor
• Up to 2,000 investors
• Could have lower minimum
investment amounts
DST vs. Tenant in Common (TIC)
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TIC
• Governed by Rev. Proc. 2002-22
• Lender underwrites each co-
owner
• Investor must sign carve-out
guarantees
• Must set up & maintain SMLLC
• No more than 35 investors
• Unanimous consent of investors
for major decisions
• Could have high minimum
investment amounts
What is a Master Tenant?
• DSTs that acquire multiple tenant properties use a Master Tenant to operate the
real estate to avoid the prohibition against new leases under Rev. Rul. 2004-86
• Usually an affiliate of the sponsor
• Sponsor provides capitalization to the real estate typically with a recourse note
to the Master Tenant
• DST enters into Master Lease with Master Tenant, and Master Tenant enters
into subleases for the real estate
• Handles day-to-day operations and property tenants (or hires a property
manager to do so)
• Makes fixed debt service and rental payments to the DST and retains the
excess, or is responsible for the short fall
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Master Lease
• Under the Master Lease, the Master Tenant receives rent from the
sublease of the property, whereas the DST receives rent from the
Master Tenant. Under the Treasury Regulations, the sharing of “gross
rents,” as opposed to net receipts, is less likely to create a partnership
arrangement.
• The Master Lease should not be a profit center; however, the IRS
requires the Master Tenant to earn a fee to prevent it from being
considered a General Partner.
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• Multi-family and student housing real estate
• Self-storage
• Hotels
• Other multiple tenant properties
• Can be used for other commercial property, subject to capital
expense and leasing commission needs
When to use a Master Tenant
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Hypothetical illustration of a commercial property sale with and without a 1031 exchange
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No exchange With an exchange
Sales Proceeds $1,000,000 $1,000,000
Less Mortgage Balance 0 0
Net Sales Proceeds $1,000,000 $1,000,000
Original Cost $100,000 $100,000
Adjusted Cost 0 0
Capital Gain $1,000,000 $1,000,000
Depreciation recapture @ 25% ($25,000) ($0)
Fed Tax on Gain @ 20% ($180,000) ($0)
State Tax on Gain* @ 6.1% ($61,000) ($0)
Medicare Tax @ 3.8% ($38,000) ($0)
Funds Available for Reinvestment $696,000 $1,000,000
*Source: 2015 U.S. state average capital gains tax per www.taxfoundation.org
Boot
What is boot?
• It is possible that in a 1031 exchange transaction, the relinquished
property (the property being sold) and the replacement property (the
property being bought) are of different value. Boot in a 1031 exchange
is money or other property that is received or deemed received in an
exchange but is not “like-kind” to other properties involved in the
transaction. The goal is to avoid boot in order to successfully execute
a tax-free transaction. If a seller does choose to receive boot, they
should be prepared to pay taxes on the value of the boot.
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• Keeping some cash from the transaction. Cash received at the closing of the
relinquished property that is not reinvested into the exchange will be considered
boot. For example, an investor sells the relinquished property for $1,000,000 but
keeps $100,000 out of the transaction for personal use. That is, in its simplest
form, cash boot.
• Debt reduction. Debt reduction boot, also known as mortgage boot, occurs
when the debt encumbering the replacement property is less than the debt
encumbering the relinquished property. Debt reduction boot can occur when an
investor is buying a replacement property that is lower in price or if an investor
has less equity in the property.
• In general, an investor that wants to avoid paying taxes in a 1031 exchange
transaction should look to purchase a “like-kind” replacement property with a
value equal to or greater than the value of the relinquished property. Investors
should also plan to reinvest all of their exchange funds and make sure the debt
on the replacement property is equal to or greater than the debt on the
relinquished property.
Some common situations in which boot may arise in a
1031 exchange transaction include:
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Example: Matching Debt & Equity
• Total Equity Replaced: $400,000
• Total Debt Replaced $550,000
• Total Real Estate Replaced: $950,000
• Replacement Requirement not met by: $ 50,000
Scenario One: Client has $1,000,000 with 60% LTV
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DST Offerings LTV Equity Amount Reinvested Amount of Debt
Replaced
Amount of Real
Estate
Replaced
DST I 0% $100,000 $0 $100,000
DST II 50% $100,000 $100,000 $200,000
DST III 60% $100,000 $150,000 $250,000
DST IV 75% $100,000 $300,000 $400,000
Cash
• Total Equity Replaced: $400,000
• Total Debt Replaced $600,000
• Total Real Estate Replaced: $1,000,000
• Replacement Requirement is met
Scenario Two: Client has $1,000,000 with 60% LTV
24
DST Offerings LTV Equity Amount
Reinvested
Amount of Debt
Replaced
Amount of Real
Estate
Replaced
DST I 0% $50,000 $0 $50,000
DST II 50% $150,000 $150,000 $300,000
DST III 60% $100,000 $150,000 $250,000
DST IV 75% $100,000 $300,000 $400,000
Cash
Example: Matching Debt & Equity
Example: Matching Debt & Equity/Adding Cash
Scenario Three: Client has $1,000,000 with 60% LTV and need
to add CASH to Investment to avoid taxes
• Total Equity Replaced: $ 400,000
• Cash Added: $ 75,000
• Total Debt Replaced: $ 525,000
• Total Real Estate Replaced: $1,000,000
• Replacement Requirement is met
25
DST Offerings LTV Equity Amount
Reinvested
Amount of
Debt Replaced
Amount of Real
Estate
Replaced
DST I 0% $250,000 $0 $250,000
DST II 50% $0 $0 $0
DST III 60% $0 $0 $0
DST IV 75% $150,000 $450,000 $600,000
Cash into
DST II
50% $ 75,000 $75,000 $150,000
• Portfolio diversification
• Value tied to bricks and mortar
• May provide hedge against inflation
• Income generated, if any, may be considered passive income (see next slide)
• Capital appreciation possible on sale
• Potential tax advantages through depreciation and other tax
deductions may provide attractive taxable equivalent yields
• In the event of a profitable sale, owners may explore the possibility
of deferring the tax on their capital gain through an IRS section
1031 exchange
Cash Investments: Potential Advantages of Owning Commercial Real Estate through Fractional Ownership
26
• IPCC’s private placement offerings may be passive income generators
(“PIGs”).
• Investments in other passive real estate programs with expenses that exceed
cash flow will result in Passive Activity Losses (“PALs”). The only way to get a
tax benefit from these passive losses, prior to the disposition of the real
estate, is to have passive income. Passive losses are not deductible against any
kind of income except passive income.
• There is no guarantee that IPCC’s offerings will generate passive income.
The rules regarding the deductibility of passive losses (whether from an
investment in an interest, or from another passive activity that potentially could
be used to offset income from an investment in an interest) are complex and
vary with the facts and circumstances particular to each investor. In addition,
any income may be subject to the 3.8% Medicare Contributions Tax imposed on
rent and other types of investment income.
Make PALs with your PIGs
27
• A hypothetical investor has $100,000 in passive activity losses. He is looking to
carry forward his losses over a 10 year period of time. He is considering an investment
which produces 6% in cash flow and has a probable life of 10 years.
• Here is a formula the investor might use to determine the amount of money he would
need to invest in order to produce $10,000 of passive income to offset his passive
losses.
• $100,000 passive activity losses divided by 10 years (carry-forward period)
• Looking to offset $10,000 in passive activity losses per year
• $10,000 passive income / 6% (hypothetical cash flow) = $166,666.00
• Investment of $166,666.00 equals $10,000 of offset taxable income per year assuming
a continuing 6% cash flow
Here’s an Example of how PIG/PAL might work
28
Regulation D/Rule 506
Rule 506 of Regulation D
• Rule 506 of Regulation D is considered a "safe harbor" for the private offering
exemption of Section 4(a)(2) of the Securities Act. Companies relying on the Rule 506
exemption can raise an unlimited amount of money. There are actually two distinct
exemptions that fall under Rule 506.
• Purchasers of securities offered pursuant to Rule 506 receive "restricted" securities,
meaning that the securities cannot be sold for at least a year without registering them.
• Companies relying on the Rule 506 exemption do not have to register their offering of
securities with the SEC, but they must file what is known as a "Form D" electronically
with the SEC after they first sell their securities.
• In any private placement offering, there are numerous risks, including that the securities
are not registered with the SEC or any state securities commissions and that there is no
public market for the interests – meaning that investors must be prepared to bear the
economic risk of an investment for an indefinite period of time and be able to withstand
a total loss of their investment.
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506(b)
Under Rule 506(b), a company can be assured it is within the Section 4(a)(2) exemption by
satisfying the following standards:
• The company cannot use general solicitation or advertising to market the securities.
• The company may sell its securities to an unlimited number of "accredited investors" and
up to 35 other purchases. All non-accredited investors, either alone or with a purchaser
representative, must be sophisticated—that is, they must have sufficient knowledge and
experience in financial and business matters to make them capable of evaluating the
merits and risks of the prospective investment.
• Companies must decide what information to give to accredited investors, so long as it
does not violate the antifraud prohibitions of the federal securities laws. But companies
must give non-accredited investors disclosure documents that are generally the same as
those used in registered offerings. If a company provides information to accredited
investors, it must make this information available to non-accredited investors as well.
• The company must be available to answer questions by prospective purchasers.
30
Under Rule 506(c), a company can broadly solicit and generally advertise the
offering, but still be deemed to be undertaking a private offering within Section
4(a)(2) if:
• The investors in the offering are all accredited investors; and
• The company has taken reasonable steps to verify that its investors are
• accredited investors, which could include reviewing documentation, such as
W-2s, tax returns, bank and brokerage statements, credit reports and the like.
31
506(c)
Reg A+
• New rules adopted in March 2015, as mandated by the JOBS Act. New rules update and expand
Regulation A, and are known as “Regulation A+”
• New rules provide for two tiers of offerings:
• Tier 1
• Offerings up to $20 million in a 12-month period
• Requires SEC and state registration/qualification
• No ongoing reporting requirements
• Tier 2
• Offerings up to $50 million in a 12-month period
• Requires SEC qualification, but not subject to review by state securities regulators
• Issuers must provide audited financial statements
• Issuers subject to ongoing public reporting requirements
• Limitation on the amount of securities non-accredited investors can purchase: no
more than 10% of the greater of the investor’s annual income or net worth
• Both Tiers permit companies to submit draft offering statements for non-public review by the SEC
before filing, permit the continued use of solicitation materials after filing the offering statement
and require the electronic filing of offering materials
• Current industry sentiment appears to be that Reg A+ will not replace Reg D offerings as the
preferred means of raising capital.
32
2015 Active Sponsors
Name % of Market
• Inland Private Capital Corp. 42.49%
• Passco Companies 14.57%
• ExchangeRight Real Estate 8.19%
• Capital Square Realty Advisors 5.02%
• Nelson Bros. 4.79%
• RK Properties Inc. 3.99%
• AEI Capital Corp. 3.13%
• Bluerock Real Estate 2.81%
• Four Springs Ten31 Xchange 1.85%
• International Capital Advisors 1.80%
Source: Mountain Dell Consulting 1031 TIC/DST market equity update, 2015 YTD
34
Example of a Substitute 1099 & 1098
Prior performance is not a guarantee of future results. The actual information contained in substitute 1099s and 1098s may differ materially from this example. There is no guarantee
that investors will receive distributions or a return of their capital.
36 Note: Figures in ()’s are negative numbers.
• During tax reform discussions, members of the Democrat leadership in the
Senate and members of the Republican leadership in the House and the
President’s budget all discussed the elimination of the 1031 exchange
and/or capping them at $1 million.
• Inland is diligently working with the national coalition of real estate industry
leaders to educate legislators and their staff on the importance of the 1031
exchange.
Section 1031 Under Attack!
38
• Formed in 2001 – a subsidiary of
Inland Real Estate Investment
Corporation
• Offers Private Placement Securities
offerings to accredited investors
seeking to own real estate directly, for
tax purposes
• Product may appeal to:
o 1031 Exchange Investors
o Cash Investors
o Investors seeking to transition from
active to passive property
ownership
• Accredited Investors only – for high
net worth, sophisticated investors
Inland Private Capital Corporation (“IPCC”)
ESPN North Campus Building – Bristol, CT 39
Snapshot of IPCC as of December 31, 2015
As of December 31, 2015:
• Offered 182 private placements
• Approximately $2.58 billion of
equity
• $5.32 billion in assets
• 451 properties in 44 states
• Offerings include many sectors,
including retail, office, industrial,
multi-family, student housing and
medical office
40
States with an IPCC Property