Tenancy-in-common (TIC) investments have been gaining in popularity in recent years, with investors enjoying tax deferral through 1031 Exchanges. Plus, fractional ownership allows you to access income from larger, professionally managed assets that would be otherwise out of reach.
However, there are TIC property investment risks and considerations you’ll want to be aware of before entering these arrangements. In this article, we will discuss these challenges and some unavoidable realities that you must understand in-depth as part of tenants-in-common due diligence. Let’s take a closer look.
1. Financing and Loan Limitations
One of the most critical considerations when investing in TIC real estate is the type of loans you can purchase. Most financing structures follow a blanket loan framework, which means that the loan is secured by the entire property instead of individual loans per investor. This structure presents a unique risk: all co-owners are jointly and severally liable for the debt.
If one investor defaults or is unable to pay debt, then the remaining co-owners must shoulder the burden. Plus, refinancing may prove difficult because lenders have strict standards and might not accept a new owner who doesn’t meet underwriting requirements. Given these risks, it’s critical that you review loan terms thoroughly and understand how these debt obligations could affect your cash flow and long-term financial strategies.
2. Liquidity and Exit Challenges
TIC interests are typically illiquid. A few factors contribute to this limitation.
- Limited Market: There aren’t many willing buyers for TIC interests, leading to delays or lower pricing.
- Lender Limitations: Some lenders will impose limits on TIC interest sales. As we mentioned, they may only accept buyers who have the financial backing or experience to enter the TIC.
- Restrictive Agreements: The TIC agreement itself may impose limits on how you can sell your TIC interests to protect group stability.
Given these restrictions, it’s best to look at TIC investments as long-term investments. If you foresee a need for liquidity in the near future, then you might be better off putting your capital in something more liquid.
3. Shared Decision Making
One of the hallmark characteristics of TICs, especially those that are eligible for 1031 Exchange tax-deferral, is that there must be shared decision-making among each co-owner. A robust agreement will outline voting rights and management authority, but it’s unavoidable for disagreements to arise. Areas like property improvements, sale timing, or refinancing are prone to these differing opinions.
Since TICs typically require unanimous decisions, any disagreements can result in slow action or none at all. As such, it’s important that you review dispute resolution and the level of influence a co-owner can assert over major decisions.
4. Tax and Compliance Considerations
Since TICs are eligible for 1031 Exchanges, they must follow IRS rules regarding such transactions. Noncompliance could result in the loss of tax-deferral status and an immediate tax hit.
Based on Revenue Procedure 2002-22, there are a few unique TIC requirements not present in other 1031 Exchange-eligible investments or arrangements.
- No more than 35 co-owners are allowed, and the TIC cannot call itself a partnership.
- Unanimous approval is needed. All co-owners must agree to major decisions surrounding the investment.
- All income and expenses must be shared strictly based on your ownership percentage.
- Investors can only perform customary landlord activities.
While Revenue Procedure 2002-22 is simply a guideline, qualified intermediaries follow it religiously. That’s because TICs that deviate significantly from these rules can face heightened IRS scrutiny. At worst, the TIC loses the 1031 Exchange eligibility, and investors have to pay the deferred capital gains taxes.
5. TIC vs DST Investments
There is another type of investment that shares the fractional ownership structure as TICs: Delaware Statutory Trusts or DSTs. Plus, DSTs are also eligible for 1031 Exchanges. There is one key distinction: TICs offer direct and active ownership, while DSTs must be passive in nature. As such, it’s a worthwhile practice for investors to consider either option based on their risk profiles and investment goals.
For those who want to maintain an active role over their investments, TICs might be the better choice. Retirees and investors who want to be more hands-off will find DSTs a more suitable option.
Wrapping Up: Tenants in Common Investment Considerations
TIC properties are promising investments that can provide tax-deferral benefits and access to income from productive properties. However, you may face a few challenges ahead: illiquidity, complex financing requirements, stalled decision-making, and more. It’s important to be aware of these possibilities and prepare in advance so you can determine whether a TIC aligns with your overall investment goals and risk tolerance.
Sources:
https://www.sgrlaw.com/ttl-articles/907/
