Tenant-in-common – investor beware

A recent trend with respect to 1031 exchanges is the explosion of the tenant-in-common (“TIC”) ownership opportunities. A tenant-in-common (“TIC”) property is investment real estate whose ownership has been split into a number of undivided fractional shares. Investors who are typically unaffiliated with each combine their exchange proceeds to acquire a large property in which each Investor owns an undivided fee interest in the property equal to his/her proportionate share of the real estate. In addition to his/her equity interest, the Investor may also acquire a proportionate share of the debt secured by the Replacement Property if debt is needed as part of the exchange.

TIC ownership can be used for any type of real estate but most of these types of properties are shopping centers, strip malls, office buildings, apartment buildings, vacant land, or other types of larger commercial real estate. Acquisition of a TIC property affords an Investor with the opportunity to acquire investment grade property, obtain a consistent monthly cash flow, participate in any appreciation, and do away with day-to-day management headaches that often accompany ownership of investment real estate. A TIC property is usually professionally managed. Under this arrangement, management of the property, negotiating leases, payment of taxes and other responsibilities are all performed, for a fee, by the professional property manager. Commonly the only thing the Investor will do in a TIC investment is collect a monthly check for the Investor’s share of the income.

TIC ownership is not for the casual investor. As with any real estate transaction it is important to perform the necessary due diligence on the property being acquired and the sponsor of the TIC program. Check the strength of the market where the TIC property is located. Thoroughly research the TIC sponsor. Ask for references and information on prior TIC property performance. Confirm the existing leases and the strength of the tenants in the property. Make sure that the leases are of adequate duration to assure long-term cash flow. Analyze the terms of the financing to determine if and when the interest rate is adjustable. Determine if you will be responsible for “capital calls” if the cash flow from the property is not sufficient to pay debt service and expenses. Most importantly, determine if there is an exit strategy should you wish to exchange out of the TIC property at a later date. Remember, that a small fractional ownership interest is not as marketable as owning 100% of a smaller property. In many instances, a TIC sponsor may restrict or limit your ability to sell prior to the decision to sell the entire property. The best advice is to perform the same level of due diligence for a TIC property that you would if purchasing the property individually.

Also, it is of critical importance that the Investor review and analyze the TIC agreement and ownership documents and structure to make sure that the TIC complies with the 1031 exchange regulations. TIC ownership has been around for many years, but its use as a replacement property solution is relatively recent. In recognition of the increased interest in TIC’s, the IRS issued 15 guidelines to assist taxpayers in determining if their TIC ownership will qualify as replacement property in an exchange. These guidelines address items such as: the allowable number of co-owners; the right to transfer or encumber the interest; the proportionate sharing of profits, losses, and debt; and, the ability of the co-owners to enter into a management or brokerage agreement for the property.

Most TIC sponsors have attempted to craft their TIC programs to substantially comply with the IRS guidelines. Any Investor considering the acquisition of a TIC interest to complete a tax deferred exchange should research the various TIC sponsors to select a sponsor whose TIC program either complies with these guidelines and demand that the TIC sponsor provide the Investor with an opinion of competent legal and tax counsel that the structure of the TIC arrangement complies with the requirements of section 1031. In addition, the Investor should consult with their own competent legal and tax counsel to assure that the acquisition of a particular TIC interest as replacement property satisfies the requirements for their exchange.

TIC’s can provide great flexibility and benefits for a 1031 exchange investor. There are plenty of well qualified and reputable TIC sponsors in the marketplace. Just remember, do your homework before you invest.