Tenants in Common 1031 Exchange

Tenants In CommonTenants in Common 1031 exchanges allow property owners to defer capital gains when replacing a fractional interest in a cash flowing property. 

Tenants in Common is a form of direct ownership that is not affected by the IRC §1031(a)(2)(D) exclusion as long as the co-tenants or owners are not treated as partners for income tax purposes.

In 1984, Congress excluded interests in partnerships from 1031 consideration by legislating IRC §1031(a)(2)(D). This was a response to taxpayers using IRC §1031 exchange as a strategy to defer gains realized on termination of burnt out tax shelters in the 70's and 80's.

In 1999 and 2000, after tenants in common interests in real estate were being sold as replacement property for 1031 like-kind exchanges, several taxpayers requested rulings from the IRS that undivided fractional interest ("TIC") arrangements would not be treated as partnerships for tax purposes. In 2000, the IRS issued Revenue Procedure 2000-46, 2000-2 C.B. 438, stating their intention to issue public guidance whether a TIC interest in real estate will be treated as a separate business entity for federal income tax purposes.

Revenue Procedure 2002-22

In 2002, the IRS issued Revenue Procedure 2002-22, 2002-14 IRB 733 setting forth guidelines that a TIC co-ownership arrangement will not be treated as an entity separate from its owners. A new market was created with more than 25 sponsors raising an estimated $1 billion in capital in 2003 for tenants in common properties. Co-owners must hold their interests as tenants in common under local law. Property title cannot be held by an entity such as a single member limited liability company. The maximum number of co-owners is limited to 35. A husband and wife are treated as a single entity as are all persons who acquire interest from a co-owner by inheritance. 

Each co-owner must share in revenue and expense allocation in proportion to the co-owner's undivided interest in the property. Debt must be shared amongst co-owners in proportion to their undivided interest. Unanimous approval of the co-owners is required on any blanket lien modification. Given a manager is employed by the co-owners for the purpose of collecting revenue, the manager must disburse to the co-owners their share of net revenue within three months from the date of receipt of those revenues. The appearance of a partnership is forbidden. Co-owners are prohibited from conducting themselves as a partnership or common business entity. Co-owners cannot file partnership tax returns. Their activity must be limited to maintenance and repair of the property.

TIC Target Market 

The target market for TIC ownership are taxpayers with a net worth in excess of $1,000,000 who are seeking a monthly cash flow without the headaches of the landlord. Caution should be exercised when evaluating prospective properties. What is the exit strategy? Is the property overvalued? Who are the tenants? There are a variety of types of tenants in common products to choose from including warehouses, apartments, marinas, office and commercial buildings, marinas, nursing homes, hotels and motels as 1031 replacement property.

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