Understanding Tenancy in Common (TIC) in CRE

While TICs may exist for various reasons, one of the reasons they are utilized is to A) accommodate one or more investors who are investing in a given investment property via 1031 Exchanges and/or B) accommodate one or more investors who plan to continue deferring potential gains in a current investment property through future 1031 Exchanges. A 1031 Exchange is a common term for a Like-Kind Exchange as defined under Section 1031 of the Internal Revenue Code.

How Does Tenancy in Common (TIC) Work?

In a TIC arrangement, each co-owner, or "tenant in common," owns an undivided interest in a property. Conceptually, it is similar to taking a property, dividing it in parts and then assigning ownership of each part to its tenants-in-common. From a legal and tax planning perspective, TICs are vastly different from a limited liability company (LLC) structure where individuals come together to actively or passively invest a property as either general or limited partners.

Why Do TICs Enable 1031 Exchanges?

One of the common reasons TICs are formed are to enable investors to utilize 1031 Exchanges. The reason that a TIC structure accommodates 1031 Exchanges is because it takes a fraction of a property and makes it 'like kind' to an entire property.4 That is meaningful for investors who are seeking to defer gains on an individually-held investment property that they recently sold.

Generally speaking, If an investor sells an individually-held investment property at a profit yet wants to reinvest those proceeds, that investor typically has two options:

1) Pay a capital gains tax on the realized investment and reinvest the net after-tax proceeds in any manner the investor wishes. This could include investing into a real estate partnership or even investing in other asset classes; or

2) Upon sale, the investor could immediately place the sales proceeds with a qualified intermediary, begin a 1031 Exchange, defer the capital gain and reinvest those proceeds on a deferred basis into like-kind property.

If the investor wishes to opt for Option 2, reinvesting proceeds of the sale of an investment property into a partnership structure, as noted above, is not like-kind - it's exchanging real property for a partnership. This is where TICs come into play.

What Are Some Key Characteristics of TICs?

• Long Term Benefits

If the investor has a long time horizon the potential benefits of deferring capital gains over a long time horizon through a series of 1031 Exchanges could be substantial. Over a period of decades, the total invested capital of the investor would potentially equal a multiple of what would otherwise be generated if the investor were to pay capital gains upon each sale and then reinvest the after-tax proceeds into the next property. 1031 Exchanges tend to be a long-term investment strategy.

• Flexibility Upon Sale

Another reason that TICs are often sought out by investors is due to the flexibility they offer TIC members upon sale. In the standard LLC ownership structure outlined above, while it is technically possible for those investors to effect a 1031 exchange and roll their proceeds into a follow-on project, doing so would require 100% of the LLC members to agree to all stick together to co-invest in a specific follow-on project. By owning an undivided interest in real property, each TIC is able to defer or realize gains on the percentage of the building it owns regardless of what the other TIC members elect to do. Each TIC is the master of its own destiny.

• Active in Nature

While certain TIC structures may be designed to enable one or more TICs to take on a more active role in management while others remain passive, generally speaking, they are intended to function as a group of co-owners. That means that critical decisions such as when to sell the property, typically require unanimous consent. In addition, if the property has a mortgage, the lender may require each TIC to be underwritten. If the investor wishes to invest passively into an investment and leave the management and key decision responsibilities to others then an LLC structure may be more suitable as that structure typically nominates a general partner to take on those duties.

Conclusion

Tenancy in Common can offer a practical solution for multiple parties to share ownership of real estate. It also offers the potential for an investor to continually defer capital gains achieved through property ownership by follow-on 1031 Exchanges that could include future TIC investments.

The ability to sell a single property (e.g. a single family rental house) and exchange it into an undivided fractional interest in a larger property (e.g. a 200-unit multifamily property) is one of the reasons why investors would seek to utilize a TIC structure as it offers a mechanism for investors to step up into an asset that would, otherwise, remain out of reach.

However, investing in real estate via a TIC comes with specific legal, procedural, and financial responsibilities that all Tenants should carefully consider. In many ways, the investor is typically an active partner in a real estate project, which means that he or she should assume a certain level of responsibility for all potential duties of an active property owner. Ultimately, a TIC structure is a tool that has the potential to offer benefits, particularly over protracted periods of time.