Many ownership structures exist when it comes to owning real estate. There are single ownership, partnerships, and LLC arrangements. Then, there are multiple-ownership set-ups, like joint ventures or tenants-in-common (TIC).
When executing a 1031 exchange involving multiple owners, the general set-up involves a TIC. A TIC 1031 exchange can help more than one owner/investor potentially defer capital gains and depreciation recapture taxes from selling real estate assets. This arrangement can be helpful for investors who no longer want to deal with hands-on management of their real estate properties.
A Brief TIC Definition
A TIC is a legal ownership structure in which multiple investors co-own undivided interests in real estate. Each tenant has a specific, fractional ownership interest in the property.
There are a few things to understand about a tenants-in-common relationship:
- Each tenant holds a share of the property, which can be of unequal size.
- During the tenant’s lifetime – and after their death – shares can be freely transferred to beneficiaries who aren’t the other TIC owners.
- TIC owners can sell or mortgage their shares without input or approval from other TIC owners.
Investors might enter into a TIC arrangement for various reasons. These can include diversification, lower minimum investments, financing access, and an ability to invest in properties they might otherwise not be able to afford.
Through a TIC 1031 exchange, anywhere from two to 35 investors join forces and contribute their relinquished properties to acquire – and eventually own – a replacement property/properties of equal or greater value using the like-kind exchange process. The IRS Revenue Procedure 2002-22 allows a fractional ownership agreement – like a TIC – as a replacement property for a 1031 exchange.
Executing a TIC 1031 Exchange
TICs embarking on a 1031 exchange must follow the same requirements as any other entity. Specifically, those involved must observe the IRS’ stringent calendar deadlines and use a Qualified Intermediary in finding and closing that replacement property. Furthermore, that replacement property must be of greater or equal value to the TIC’s combined resources.
Investors who are part of a TIC must also follow specific IRS guidelines for a successful 1031 exchange, including the following:
- The number of TIC owners is capped.
- Co-owners involved with the arrangement must own their shares for at least six months before selling their interests.
- Any decisions involving material impact on the property, or its owners must be approved unanimously by all TIC members.
- Co-owners are responsible for costs related to debt servicing and other expenses based on their share percentages.
The TIC 1031 Takeaway
There can be some positives involved with the TIC 1031 exchange. But, due diligence of the targeted replacement property/properties and other co-owners is essential before starting this path. Investors interested in becoming involved with a TIC-like-kind exchange should be sure to talk with their legal and tax experts before and during the process.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Because they are private placements, TICs are illiquid securities. There is no secondary market for TIC investments. Moreover, the form of ownership may require unanimous consent to sell a TIC interests.
Like any investment in real estate, if a TIC property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions.
TIC properties employ professional asset and property management, so while TIC co-owners vote on major issues, they do not have direct say over day-to-day property management situations.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
