Tenants-in-Common:
A Form of Tax Free Real Estate Exchange
A tenants-in-common 1031 exchange is a class of real estate ownership in the United States of America whereby two or more persons own a real estate asset and have an undivided, fractional interest in the asset. Under the guidelines of a tenant in common (TIC) transaction the percentage of ownership, and therefore the number of shares, are not required to be equal. The fundamental difference between a TIC and a regular commercial real estate asset is that the TIC has typically been transformed into a security, just like stocks and bonds, and is, therefore, subjected to the laws and guidelines of the Securities and Exchange Commission (SEC). The requirements of the SEC in terms of financial disclosure and investor suitability tests are in place to protect an investor from being led into a deal for which may not be suitable for him or her. At the conclusion of the sale of a TIC each co-owner receives an individual deed at closing for his or her undivided percentage interest in the property. For all intents and purposes, a TIC owner has the nearly the same rights and benefits as a single owner of property, except when it comes to the sale of the asset.
Just like any other real estate asset, the ownership interests in a TIC can be passed along to another person as a part of the person’s estate, but unlike normal real estate assets, the ownership cannot be easily sold to another individual. The reasons for this are the SEC requirements for qualifying and selling a TIC to an investor. The heirs of an investor are not considered a “new” investor, so the stringent regulations are not required to pass this asset on to their designated beneficiary.
Even though the TIC form of ownership has been used for many years, its popularity has been increasing dramatically due to a landmark IRS ruling in 2002. Exchangers must be careful when trying to locate and close on suitable replacement property due to IRS time requirements. There is a 45 day identification period and a 180 day closing period that restricts the timing of 1031 TIC exchanges.
An IRS ruling in 2002 greatly expanded the pool of properties available for 1031 tax deferred exchanges, particularly for individual investors. The ruling pertains to joint tenant in common (TIC) legal structures, which allows individuals to own a fractional interest in a property. This allowed investors with smaller amounts of investment capital and equity to become a co-owner in office buildings, apartment complexes and shopping centers. While the legal format of tenant in common investment ownership existed for many years, the 2002 ruling gave investors the security and confidence that the IRS would allow the tenant in common structure for 1031 TIC exchanges.
The ruling, coupled with an increased interest in 1031 TIC properties, has led to a rapid growth in tenants in common investments. A 1031 TIC structure allows a group of investors to pool their resources and purchase better quality properties than they might otherwise have access. Typically these more prestigious properties have higher quality lessees which reduce the owners’ risk. The properties are managed by a professional property management service which eliminates the need for the investor to be involved in the day-to-day operations.
1031 exchanges with tenant in common ownership has become the driving force in today’s commercial real estate sales transactions. While TIC interests are not the right choice for all investors, 1031 TIC exchanges can be a good match for investors who are seeking a steady cash flow with a professional property management service looking after the day-to-day operations. In summary, the advantages of 1031 TIC real estate exchanges buying into class A commercial real estate are numerous and just may be the perfect investment vehicle for the right investor looking to ad real estate into his or her portfolio.