Tenancies in Common & Like Kind Exchanges

Tenancy in common (TIC) interests have become extremely popular as replacement properties in like kind exchanges. A TIC interest represents an ownership slice of a larger fee interest, which is evidenced by an individual deed. A TIC owner possesses the same rights as would an owner in fee simple absolute.

Given their recent popularity, the most desirable TIC investments also command substantial premiums. However, costs associated with the TIC properties also reflect economies of scale. Since multiple owners may pool their resources, a TIC interest in high quality commercial property may be acquired for as little as $200,000. A smaller initial investment translates into an opportunity to diversify.  TIC properties generally consist of high quality triple net leased buildings or office buildings whose cost may range from $1 million to more than $10 million. A TIC sponsor will generally analyze leases, conduct demographic studies, and determine desirable investment property. The sponsor may enter into a master lease with the TIC interest holders, and then lease the property to subtenants. Secure monthly cash flow can be anticipated, since most tenants would be creditworthy and would sign multi-year leases. The TIC sponsor will typically provide quarterly updates and annual reports to investors, who will have little if any day-to-day management responsibility. The investment is particularly appealing for taxpayers who wish to minimize their involvement in replacement property.

A TIC property marketed through a Private Placement Memorandum (PPM) can often be identified and closed within the 45-day identification period. A second TIC property owned by the sponsor can also be identified as backup replacement property. Before TIC property is acquired, a business plan of 3 to 7 years, as well as an exit strategy, may already be in place. As mortgage loans are paid down, and as the market value of the property increases, the taxpayer’s equity will increase, making it possible to “trade up” with sequential Section 1031 exchanges.

To illustrate, assume the taxpayer relinquishes property and identifies the following TIC properties: (i) a Class A 300,000 square foot distribution center in Chicago; (ii) a new 265 unit apartment community in Las Vegas; (iii) a shopping center in New Orleans; and (iv) an oil and gas interest in Alaska. Not only has the taxpayer diversified his investment, but he has chosen a mix of properties with differing cash flows and investment potential. The distribution center in Chicago may have a high cash flow (i.e., capitalization); the New Orleans shopping center may offer unique federal, state and local tax advantages; the Las Vegas apartments may possess enhanced growth potential; and the Alaska oil and gas lease may offer attractive current write-offs.

In response to increased taxpayer interest in TICs as replacement property, the IRS issued Revenue Procedure 2002-22, which permits acquisition of TIC interests by a group of owners, but prevents TIC owners from operating as a de facto partnership. The ruling states the circumstances in which a group of small investors acquiring undivided interests in a larger single-tenant replacement property will be viewed as acquiring TIC interests or undivided fractional interests (UFIs), rather than as partnership interests.

Until recently, the IRS had issued little guidance with respect to how the taxpayer could meet the prolific requirements of Revenue Procedure 2002-22. Since replacement property must be identified within 45 days, the taxpayer has had to rely on tax opinions of counsel as to whether the requirements of Revenue Procedure 2002-22 were satisfied. PLR 200513010 ruled favorably on a multi-tenant net leased property with a blanket mortgage. The ruling suggests that (i) the IRS will not view the multi-tenant aspect of the building as creating a partnership; (ii) a blanket mortgage will not violate the guidelines of Revenue Procedure 2002-22; and (iii) the power of the manager to exercise discretion when leasing, without obtaining the express consent of the owners, will not cause the UFI to fail to constitute eligible replacement  property.

To obtain a favorable ruling under Revenue Procedure 2002-22, tenants in common must each possess a right to participate in management decisions. Certain decisions, such as leases to new tenants, require the approval of all co-owners. However, a prospective tenant might not agree to wait a month for approval by all co-owners. PLR 200513010 implies that certain business decisions requiring expeditious action may be put to co-owners for their approval within a fairly short period of time without violating Revenue Procedure 2002-22. Therefore, a notice might be sent to tenants providing that their implied consent will be assumed unless they respond within 15 or 30 days.

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