Stocks are a convenient way for investors to trade the profit/loss of a company. This same tradeability and lack of investor participation make stocks securities. Do the owners of real property structured under a tenants in common hold a security? That is the question we’ll delve into in this article.
What Is A Security?
Security is defined in the Securities Exchange Act of 1933, which is fairly complex. We’ll try to use a shorter, more simplified definition. Basically, if it can be traded and investors do not have any participation in its income generation, it’s a security.
For example, stocks are securities. Investors can trade them and do not participate in the enterprise (companies do that). The enterprise is packaged into a stock and can be traded. All without the help of the investor, since the expectations of profits are garnered from the activities of others (i.e., company management).
In contrast, real estate requires an investor to be hands-on (i.e., property management) to generate income. These rules are part of what’s called the Howey Test.
An investor can indeed buy a REIT, which is a security and provides the investor with exposure to real estate. However, a REIT and real property are two very different things. A REIT is passive for the investor. Real property is not passive (i.e., requires property management) and comes with potential tax advantages (i.e., interest and depreciation expenses). REITs don’t have those same potential tax advantages.
Tenants in Common And Securities
TIC investors own interest in real property. This interest is divisible, which means that each individual owns a specific percentage of the property. These percentage interests are called shares.
The question asked in this article is — are the TIC interest shares considered a security?
The answer largely depends on how the TIC was structured. A TIC structured in a way that requires the owners to manage the property likely does not qualify as a security. The managerial and profit generation efforts come from the owners and not the activities of others.
However, a TIC interest sold to an investor by a sponsor may qualify as a security. This is because the property’s profits come from the efforts of others, not the investor.
A TIC that qualifies as a security is called a securitized real estate investment and requires a private placement memorandum.
It’s important to know if a TIC investment is a security, especially for those seeking a 1031 exchange into a TIC interest. If the TIC is a security, a 1031 exchange cannot be performed. Additionally, a TIC security does not have the same preferential tax treatment as real property.
If an investor’s goal is to do a 1031 exchange into a TIC, seeking legal advice from a real estate attorney can help determine if the TIC is properly structured for a 1031 exchange.
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.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
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.
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.