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1031 TIC - A Primer
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Who should consider Tenant-In-Common ownership?
What are the advantages of Tenant-In-Common ownership?
What are the limitations of Tenant-In-Common ownership?
Who should consider Tenant-In-Common ownership?
Real estate investors who could potentially benefit from a TIC investment include investors who want to:
- Sell their property and defer taxes through an IRC §1031 exchange.
- Sell their property and avoid depreciation recapture.
- Reduce the time, effort, and stress of locating quality replacement property.
- Reduce the challenge of locating property on their own within 45 days.
- Own institutional-grade commercial property.
- Benefit from the knowledge and experience of commercial real estate experts.
- Potentially increase depreciation deductions.
- Eliminate day-to-day management responsibilities of owning real estate.
- Diversify real estate holdings.
- Potentially receive cash flow from real estate investments.
- Receive estate tax planning benefits.
- Have the ability to sell current property for fair market value without having to increase the asking price to include capital gain taxes that would have to be paid.
- Potentially receive income from real estate on a tax-advantaged basis.
What are the advantages of Tenant-In-Common ownership?
TIC ownership might provide to investors the following advantages:
- Provides a Viable Source of §1031 Replacement Property: Many real estate investors find it difficult to locate quality replacement property that meets their investment objectives and enables them to complete a §1031 exchange within the specified timeframes. TIC ownership creates an additional form of real estate inventory for §1031 replacement properties that investors may wish to consider.
- Elimination of Management Responsibilities: Many real estate investors no longer desire the day-to-day burdens and responsibilities of being a landlord and do not want to be involved in active property management. Many TIC ownership programs have professional management which may have extensive experience in all phases of owning, managing and operating institutional grade commercial real estate.
- Institutional-Grade Commercial Property: Provides investors the ability to acquire commercial or Class A properties, which in many cases are leased to national credit tenants. For many real estate investors who have "done it themselves," they have never had access to these types of commercial properties that have historically been accessible only by pension funds, insurance companies, and other large institutional investors, due to the overall value of the property.
- Increase the Tax Efficiency of Real Estate: Real estate investors are able to defer capital gain and depreciation recapture taxes by performing a §1031 exchange and using TIC ownership as the replacement property.
- Diversification: With potentially low minimum equity requirements, investors can diversify by purchasing a portfolio that consists of TIC ownership programs in different locations. This provides flexibility with a variety of property types, tenants, industries, etc.
- Flexibility for §1031 Exchanges: TIC exchanges provide the flexibility to meet the equity reinvestment and debt requirement needed for full tax deferral and generally avoid taxable boot.
- Flexible Investments: As little as $200,000 of equity can qualify for TIC ownership and an individual program could accept as much as $20 million from a single investor.
- Potential Monthly Cash Flow: Many properties across the United States have appreciated in the last decade. In many areas, rental income has not kept pace with the appreciation.
- Appreciation Potential: TIC investors are able to participate in the appreciation of an investment grade commercial property, if any.
- Pre-Packaged Financing: Companies that structure TIC ownership programs generally acquire the property, arrange financing, perform due diligence and fully manage the property. Ordinarily the debt is non-recourse.
- Back-up Property within the 45-Day Identification Period: Some investors performing an exchange have difficulty identifying and closing on replacement property within the 45-day identification period. A fractional interest in a TIC ownership property may help an investor meet their identification requirements before the identification period expires.
- Stepped Up Basis at Death: TIC assets that are passed on to beneficiaries receive a full step up in basis when the original TIC owner passes away. This simply means that capital gain taxes will be forgiven after death. (Note: Consult with a tax or legal advisor regarding the tax laws that may be applicable.)
- Due Diligence: The broker/dealer, sponsor and lender often perform their own due diligence. In addition, independent third party due diligence reports may also be available.
What are the limitations of Tenant-In-Common ownership?
TIC investors face the same basic risks that other real estate investors face such as market risk, economic risk, location risk, and legal risk, even though they only have an undivided fractional interest in the property. While TIC ownership can provide a real estate investor with numerous benefits, it is important to understand the limitations and risks of TIC ownership such as:
- Lack of Liquidity: TIC investors must understand they are investing in real estate and a TIC transaction should be viewed as a long-term commitment. A TIC investor does not have a large group of ready and willing buyers for their respective fractional TIC ownership interest if they decide to sell their TIC interest before the TIC property is ultimately sold. Currently there is no secondary market for TIC ownership interests. Some TIC sponsors may help a TIC investor sell their interest to other TIC investors or to an outside investor.
- Exit Strategy: There is generally no defined exit strategy for TIC programs other than the ultimate sale of the TIC property. Most TIC sponsors believe that they will hold a property for 4 to 10 or more years before selling the property. Additionally, an exchange in the future may be difficult because the TIC ownership percentage may be highly leveraged.
- Lack of Experience: Few real estate investors understand TIC ownership. The majority of accountants, attorneys and real estate professionals do not fully grasp all the issues involved with TIC ownership. Many real estate investors do not have much experience in commercial real estate and may not be fully aware of the risks involved with commercial property ownership.
- Rate of Return: There is no guarantee that a TIC will provide a higher rate of return than other real estate investments. There is no guarantee of consistent cash flow (or distributions) during the term of ownership. In fact, there is no guarantee that the TIC will make any money at all and investors may lose principal invested.
- Co-Owners: Every TIC investor is locked into a long-term business relationship with many co-investors who have not known each other previously. Co-investors will have to agree, in most cases unanimously, to all major decisions affecting the TIC property.
- Capital Call: TIC ownership is actual real estate ownership. If there is major work that needs to be done on the TIC property, or if a major tenant moves out, there could be a capital call placed on all TIC investors that is not covered by the capital reserve maintained for the property. This means a TIC investor could be required to put more money into the TIC property. Many TIC programs have an amount set aside in their operating budget to cover what the sponsor views as anticipated future costs.
- Short-Term Debt Structure: To take advantage of low short-term interest rates, some sponsors are securing short-term financing, such as five-year loans. If the TIC property has not sold within the 5 year time period, the property will have to be refinanced and the rate on the loan may be adjusted to higher current market rates. Many investors believe that interest rates will be higher in the future. Higher future interest rates may force the investor to accept a lower overall rate of return.
- Costs and Fees: Often there are many costs and fees involved in the sale of TIC ownership programs which may outweigh the benefits of tax deferral. There are costs and fees earned by the Registered Representative and others involved in the acquisition, syndication, packaging, distribution and sale processes. Other costs include property management and liquidation or disposition fees and financing or rate buy-down fees.
- Estate Taxes: While it is true that a TIC investor may receive a "step up in basis" when they pass away, it is also true the value of the TIC interest will be included in the estate of the decedents if not properly planned.
- Leverage: The higher returns achieved with leverage must be weighed against increased risk if the overall market or a specific property depreciates in value.
- Recourse: TIC investors may assume liabilities that extend beyond their TIC investment. These can be triggered by bankruptcy, attempted termination of management, fraud or misrepresentation or a filing action for partition.
Source
Asset Preservation, Inc., www.apiexchange.com
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