Quite simply, Tenants in Common is nothing more than a form of legal ownership of property. Some of the most common forms of ownership are as follows:
- Sole Ownership – Owned entirely by one person.
- Joint Tenancy – Property owned by more than one person. Each tenant has an undivided right to possess the whole property and a proportionate right of equal ownership interest. Title automatically passes to the surviving tenant at death.
- Tenancy in the Entirety – A special form of joint ownership that requires both owners to approve any sale of the property. The joint tenants are husband and wife and neither spouse can transfer their interest without the consent of the other.
- Tenants in Common – a form of ownership for two or more owners. The individual interests do not have to be equal and the owners enjoy a proportionate right to the property. Title passes to the estate of the deceased owner and the person named by the estate assumes their proportionate title to the property and becomes the new tenant in common with the surviving tenants in common.
The Tenants in Common structure is not new. The structure has, however, received considerable attention since the IRS revenue ruling (Revenue Procedure 2002-22), which essentially laid out the guidelines in which tenants in common investments should qualify as an eligible property for purposes of a 1031 exchange. Tenants in common owners are considered direct owners, are listed on the deed and are considered a direct owner in the property with an undivided interest. If the tenants in common owners invest in real estate, the owners receive their proportional share of the income, tax benefits, and appreciation of the property.
Tenants in Common investments are structured by “sponsors.” These sponsors script a Tenants in Common Agreement, which typically calls for employment of professional management. Major decisions regarding the investment property are determined by vote of the tenants in common owners.
What is TIC - 1031 TIC Exchanges? (Tenant in Common Property)
1031 TIC Exchanges are a form of real estate asset ownership in which two or more persons have an undivided, fractional interest in the asset, where ownership shares are not required to be equal, and where ownership interests can be inherited. Each co-owner receives an individual deed at closing for his or her undivided percentage interest in the entire property. In brief, a TIC owner has the same rights and benefits as a single owner of property.
Although the TIC ownership form has been used for many years, its popularity has been increasing dramatically due to a recent IRS ruling. Exchangers often have difficulty in locating and closing suitable replacement property within the 45 day identification period and the 180 day closing period. 1031 TIC exchanges can significantly reduce these risks.
The Mechanics of a 1031 Tenants in Common Exchange
Investors have long used 1031 exchanges to defer taxes, while swapping old properties for newer properties. The reasons for swapping real estate vary greatly. In today's market, finding real estate values can be a challenge and individual investors have been somewhat limited to residential properties and small commercial structures. An IRS ruling in 2002 greatly expanded the pool of available properties, particularly for individual investors. The ruling pertains to joint tenant in common (TIC) legal structures or co-owned real estate (CORE), which quite simply, allows individuals to own a fractional interest in a property, such as an office building, apartment complex or shopping center. While tenant in common investment ownership has been around for quite some time, the 2002 ruling allowed investors to feel confident that the IRS was on board with the tenant in common structure for 1031 TIC exchanges, igniting a cottage industry.
The ruling, coupled with an increased interest in 1031 TIC properties, has led to a rapid growth in tenants in common and CORE investments. A 1031 TIC structure will allow investors to pool their resources and purchase larger, higher valued and better positioned properties than they might otherwise have access. Typically these more prestigious properties can also open doors to high quality lessees, such as Fortune 500 companies and government entities, reducing owner tenant risk. Real estate firms (Sponsors) organize the properties with professional management, removing day-to-day owner concerns.
TIC 1031 tenant in common exchanges are typically handled through broker-dealers and are under the oversight of the Securities and Exchange Commission (SEC). While there are 1031 TIC sales occurring outside of the SEC supervision, currently there is quite a bit of controversy over these properties and there may be a movement by the SEC to pull these properties under their regulatory umbrella.
The typical TIC replacement property investor meets all or many of the following scenarios:
- wishes to greatly reduce their management responsibilities
- has left over funds (boot) from another direct 1031 investment
- does not want to pay capital gains or depreciation recapture taxes
- seeks Grade "A" properties with large, well financed tenants
- cannot find suitable direct property in the 45 day period
- desires to remain in the real estate market for income and potential of capital gains
- Desires a higher degree of diversification both in properties and regions.
The TIC replacement investments are not without pitfalls. There has been a plethora of sponsors that have popped up following the 2002 IRS ruling. A few things that you should consider before entering in to any 1031 TIC investment*:
- How long has the sponsor been in business?
- Does the sponsor have experience not only in structuring deals, but also successfully selling the properties for the TIC replacement property investors?
- Do investors have control to hire and fire managers?
- What is the exit strategy for the property?
- Does the sponsor have experience in executing their stated strategies?
- Does the TIC 1031 broker have experience in marketing TIC deals?
- What percentage of the broker's business is related to TIC replacement properties? (Remember: TIC brokers are securities licensed and can sell other products. You should strongly consider utilizing a TIC broker that makes TIC exchanges a core part of their business)
- How solid are the tenant leases?
- How solvent are the tenants?
- Is the property relatively new and is it located in an area that is doing well economically?
It would be an understatement to say that 1031 exchange has become a driving force in commercial real estate sales transactions. While TIC interests are not perfect fits for all investors, 1031 TIC exchanges can be a good match for investors that are looking for steady cash flow and limited management hassles on their replacement properties. The advantages of 1031 TIC institutional grade real estate are clear and compelling and the future is bright for these types of investment vehicles.
*This list is by no means a complete list necessary to perform complete due diligence, but hopefully provides potential investors with some important points to consider.
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