Being a co-owner in a tenancy-in-common (TIC) can offer advantages, such as access to larger properties, but it may also introduce structural limitations. Investors seeking greater control or portfolio simplification may consider exiting a TIC interest. This raises an important question: can a TIC interest be exited through a 1031 exchange?
The answer may be yes—if the TIC interest meets certain IRS requirements. A like-kind exchange can offer a tax-deferred strategy to preserve capital and transition into a more manageable ownership structure, subject to qualification.
Below, Realized 1031 has shared a guide to help you understand how a TIC 1031 exchange can happen. Let’s take a closer look.
What Is a Tenancy in Common?
A TIC is a legal ownership structure where two or more investors hold fractional interests in the same real estate asset. These are undivided interests, meaning everyone has equal rights and responsibilities over the property. TICs offer a way for smaller investors to gain exposure to high-value properties without the full financial commitment of sole ownership.
However, shared control can present challenges—especially in areas like property management, cash distribution, and consensus over sale timing or reinvestment decisions.
What Is a 1031 Exchange?
A 1031 exchange is a tax-deferred real estate transaction governed by Section 1031 of the Internal Revenue Code. It allows an investor to sell a property held for business or investment purposes and reinvest the proceeds into a “like-kind” replacement property without immediate recognition of capital gains.
The “like-kind” requirement refers to the nature or character of the property, not its grade or quality. Both the relinquished and replacement properties must be held for qualified use. When structured properly, a 1031 exchange can defer capital gains tax and support long-term wealth preservation—though this deferral is contingent on ongoing compliance and reinvestment.
TIC to 1031 May Be Eligible Under Certain Conditions
The IRS imposes many rules for 1031 exchanges, including that only qualifying real property may be exchanged. How are fractional interests in a TIC allowed, then?
Potentially—if specific conditions are met. IRS Revenue Procedure 2002-22 outlines factors that the IRS will consider when determining whether a tenancy-in-common (TIC) interest will be treated as real property for Section 1031 purposes, rather than as an interest in a partnership or business entity. Key eligibility considerations include:
- The number of co-owners is generally limited to no more than 35, as larger ownership groups may resemble a business entity.
- Each co-owner must hold title directly to the real property as a tenant in common. Interests held through entities like LLCs or partnerships generally disqualify the arrangement from 1031 treatment.
- Each co-owner must receive income that is proportional to their ownership interests.
- Major decisions (e.g., refinancing or sale) must be made through unanimous consent. However, daily operations don’t need to be centralized.
- Each TIC interest must qualify as real property held for investment or productive use, as required under Section 1031.
How To Exit a TIC Through a 1031 TIC Exchange
There are two primary ways you can use 1031 exchanges to exit a TIC.
Scenario 1: Selling Your Individual Interests
Because TIC interests are considered undivided ownership in real property, an individual co-owner may be able to sell their fractional interest and reinvest the proceeds through a 1031 exchange. This approach allows you to transition into a wholly owned property or another TIC structure, subject to IRS requirements.
However, selling a fractional interest can be challenging. Many investors prefer full control of a property, which may limit the pool of prospective buyers. Additionally, TIC agreements often include transfer restrictions or require consent from other co-owners.
Scenario 2: Selling the Entire Asset
You can convince the other owners to make a unanimous decision and sell the property. Upon closing, each owner receives their proportionate share of the sale proceeds and may independently initiate a 1031 exchange into their chosen replacement properties. To qualify, each investor must meet the IRS’s strict timing rules—identifying replacement property within 45 days and completing acquisition within 180 days.
Both approaches require careful planning to maintain 1031 eligibility and avoid triggering capital gains tax.
Wrapping Up: 1031 Tenants in Common Eligibility
For those who are asking if you can exit a TIC through a 1031 exchange, this strategy may be permitted under IRS guidelines, as long as the TIC follows the structure and other requirements set by Revenue Proclamation 2002-22. If properly executed, a TIC interest may qualify for like-kind exchange treatment, allowing the investor to defer capital gains taxes and reinvest proceeds into other qualifying real property.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
Sources:
https://www.irs.gov/pub/irs-drop/rp-02-22.pdf
