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What is a Tenant In Common (TIC)?
Holding title as a Tenant In Common is defined as a form of asset ownership in which two or more persons have an undivided fractional interest in the asset in which the ownership interests are not required to be equal, can be inherited and each co owner has a separate deed.
The IRS has provided 15 guidelines by which a Tenant In Common (TIC) ownership interest will qualify for a tax deferred 1031 exchange. These guide lines can be found in Revenue Procedure 2002-22 and are as follows:
1. Tenant In Common Ownership: There can be no other way of holding title to the property other than Tenants In Common.
2. Number of Co-Owners: There can be no more than 35 persons who acquire interest to the property. The only exceptions to this that a husband and wife are treated as a single person as is all persons who acquire interests from the co-owner though inheritance.
3. The Co-Ownership may not be treated as a single Entity: The group of Co-Owners cannot treat itself as a partnership. Example: A partnership will file a single tax return; have one name for the entire group. The IRS will generally not approve of a property if the Co-Owners held title to the property in a partnership or corporation just prior to the formation of the TIC ownership.
4. Co-Ownership Agreement: The co owners may, but are not obligated to, enter into a limited co-ownership agreement that may “run with the land”. As an example: The agreement could include, among other things that a co-owner must give the other co-owners first right of refusal to purchase their interest (which must be at fair market value and determined on the date the right is exercised).
5. Voting: There must be unanimous approval by the co-owners of: The negotiation/renegotiation of a contract for, and hiring of a property manager; the sale of the Property, any lease for a portion or all of the property, and any “blanket lean” (mortgage) and any negotiation/renegotiation of such. For all other actions the co-owners may agree to be bound by the outcome of a vote decided by those holding 50% or more of the undivided interests.
6. Restrictions on Alienation: In general each owner must have the right to transfer its interest in the property without approval of any person. Exceptions to this rule are any restrictions required by a lender as long as they are consistent with “customary commercial lending practices”. Example: The lender may require that the whole property be refinanced to allow one of the owners to transfer their interest in the property. If you think you will sell prior to the end of the holding period, be sure to check this point with the sponsor prior to signing loan documents.
7. Sharing Proceeds and Liabilities upon the Sale of the Property: When the property is sold all debt must be paid off prior to distribution of any profits to owners. Neither the manager, the sponsor nor other co-owners are permitted to advance funds for the expenses to a co – owner unless the advance is “recourse” to the co-owner and for a term of less than 31 days.
8. Proportionate Sharing of Profits and Losses: Each owner must share in all of the income and expense associated with the property according to the proportionate share of its undivided interest.
9. Proportionate Sharing of Debt: Each owner must share in debt that is secured by a mortgage on the property, in proportion to its undivided interest.
10. Options: Any co-owner may issue an option to purchase its interest provided that the price reflects its fair market value of the property at the time the option is exercised.
11. No Business Activities: The co-owners’ activities must be limited to those customarily performed in maintaining and repairing the property. This rule does not apply if the co owners owns an undivided interest for less than 6 months (this part of the rule is meant to allow for a sponsor to prepare the property to be sold as a TIC).
12. Management and Brokerage Agreements: The fees charged for all brokerage and management agreements must be at fair market value, must be renewed no less than once a year, and can be the sponsor or a co-owner but not a lessee. The fees negotiated for these services may not be dependant on the amount income received from the property.
13. Leasing Agreements: All lease agreements must be valid for Federal Tax purposes and reflect their fair market value for the specific type of use specified in the lease. The amount of rent cannot depend on the amount of any income or profits produced by the property with the exception of an amount based upon a percentage of sales receipts of the lessee (percentage rent).
14. Loan Agreements: Any lender for debt that encumbers the property may not be a related person to the sponsor, any co-owner, the manager or any lessee of the property.
15. Payments to the Sponsor: Any payment to a Sponsor for the acquisition of the TIC interest must reflect the fair market value for the service and the value of the interest at the time of the purchase.
Although holding title in the form of Tenants In Common (TIC) has been around for a long time; for most of us the concept is new. The above guidelines are provided by the IRS to structure TICs in a way that will qualify them for a 1031 exchange, providing another avenue for an investor to continue to increase their cash flow and networth.
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