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Tenants-in-Common in Real Estate Ownership: Everything You Need to Know
What is a TIC (Tenants In Common investment)?
How is TIC Ownership Structured?
Real estate provides a range of potential benefits for both novice and experienced investors. They can possibly earn recurring income from rent, as well as income from appreciation if their properties increase in value during the time they hold the assets. Investors can defer capital gains taxes by completing 1031 exchanges, and also realize significant depreciation deductions when filing their annual income taxes.
Investors use many investment strategies purchase fractional shares in a wide range of real property
assets. The Tenant-In-Common arrangement allows investors to join a pool of co-owners and purchase assets that oftentimes would be beyond their reach as solo investors. TIC opportunities are often pre-packaged by a sponsor and include professional property management. Financing may already be secured as well, which can lead to greater efficiency in identifying, acquiring, financing and closing on a TIC property for a 1031 exchange.
Investors considering this type of ownership structure to complete a 1031 exchange should consult with qualified accountancy and tax professionals to ensure they adhere to important IRS guidelines and timelines.
What is a Tenant in Common?
Tenant-In-Common, or TIC, is a legal ownership structure wherein multiple 1031 exchange investors co-own individual undivided interests in real property assets. Owners can hold unequal shares, and they can sell or mortgage their shares independently from other tenants. Co-owners aren’t actually tenants in their properties, though -- the true “tenants” are the property leasees.
TICs have some specific IRS guidelines that investors must meet to be eligible for the tax-deferred benefits of a 1031 exchange. Foremost among these is that taxpayers must reinvest the proceeds from the sale of real property into like-kind assets; benefits don’t apply if those proceeds are reinvested in REITs, partnerships or LLCs.
Additional IRS guidelines for Joint Tenancy-In-Common arrangements include:
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Co-owners must share costs related to debt servicing and other expenses based on their pro rata shares -- same with income distributions. Only the parties listed on title can receive profits or pay for expenditures.
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The number of co-owners is capped at 35.
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TIC sponsors can’t be compensated through income or returns to investors.
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All decisions regarding material usage must be unanimously approved by all co-owners.
Another important aspect of TICs is that co-owners can bequeath their shares to an heir of their choosing upon their death.
Why Choose a Tenant-In-Common Arrangement for a 1031
Exchange?
Savvy investors often complete 1031 exchanges to defer capital gains taxes on the sale of real property by reinvesting those funds in like-kind assets. A Joint Tenants-In-Common exchange happens when two or more owners share fractional interests in a property purchased through the 1031 exchange process.
There are many reasons investors may want to consider this option. Since there can be up to 35 investors, minimum investment
thresholds can be much lower for individual investors. Investment amounts also can be flexible since co-owners can hold unequal ownership stakes.
Lower minimum investment amounts also allows individual investors the opportunity to spread their investment dollars around into multiple properties and different asset classes. This portfolio diversification can prove important to weathering regional market downturns. Having a pool of investors also provides a deeper team of resources to draw from for day-to-day property management decisions, lease negotiations and other important aspects of being a landlord -- you don’t have to go it alone.
Pros of Investing in a Tenant-In-Common Property
Many investors complete 1031 exchanges into a Tenant In Common property to defer capital gains taxes after the sale of a real property asset. In addition to some of the benefits outlined above, there are multiple reasons why investors should consider a 1031 exchange into a TIC arrangement:
Timing and pre-packaging
The IRS has strict regulations on completing a 1031 exchange. Investors have 45 days to identify a like-kind replacement and 180 days to close on their new investment. Sponsored TIC properties simplify and expedite this process in numerous ways. All due diligence, such as inspections, financials and rent rolls, has already been completed by the sponsor. Financing also is already set up.
Depreciation
Investors can incorporate annual depreciation deferral deductions on their tax statements.
Potential recurring income
Lease payments by tenants are distributed to the TIC property owners. Funds are deposited directly into your bank account on a monthly basis, when applicable.
Diversification
Investors can exchange into multiple properties, which can provide portfolio diversification by asset type and geographical region.
Limited expenses and fees
Most TIC investment properties have minimal associated fees since sponsors have already completed appraisals, reports and other basic investment documentation. Closing costs also are not usually included in the exchange process.
How is a Tenancy-In-Common Different
From a Delaware Statutory Trust?
TIC arrangements share some similarities with Delaware Statutory Trusts (DSTs). Both allow fractional investments and can be used in a 1031 exchange. However, there are some key differences. Among them:
Passive ownership
DSTs are professionally managed by a property manager and the DST sponsor. Owners are not involved in the daily operations of their assets. With TICs, all owners are required to vote unanimously on important property management issues that will be carried out by the TIC sponsor or property manager.
Unlimited investors
A Tenant-In-Common can have up to 35 individual investors. There are no limits on how many investors can own fractional interests in a Delaware Statutory Trust.
Financing
Debt taken on in a DST isn’t assumed by individual investors; rather, it’s assumed by the DST since the trust is the title holder of the property. DST investors won’t show mortgage payments on their balance sheets. It’s the exact opposite for a TIC. Each co-owner is a titleholder and will have to make mortgage payments. That fact often makes it difficult to obtain financing for a Tenant In Common arrangement since each owner must be approved by a lender.
Investment thresholds
In a TIC, ownership is limited to 35 investors, so each owner may have to put up a larger investment sum when purchasing higher-value assets. DSTs, on the other hand, have an unlimited number of investors, so investment minimums are usually lower. Tenant-In-Common investments may require a $500,000 investment stake compared to $100,000 for a DST.
Executing a 1031 exchange
Both ownership structures qualify for like-kind exchanges of equal or greater debt. That last, though, can make DST exchanges easier to complete since investors have lower financing ratios of non-recourse debt.
When Co-owners Have Conflicting Interests -- Petition to Partition
A major benefit of TIC ownership is the ability to bequeath your interests to your heirs. But sometimes those heirs might not want to own real estate and are looking for a cash-out. Since Tenants-In-Common owners cannot sell an asset without unanimous owner agreement, this can create problems if one or more owners want to liquidate their shares of the asset. They can legally force a court-ordered sale through a process called partition by sale.
This can be a time-consuming, costly and emotionally draining process for co-owners -- the petition process can last up to 12 long months. In some cases, the asset could be disposed of on the steps of your county courthouse via auction. In others, a judge might order a forced sale through receivership. Both scenarios could result in a reduced sale price and an undesirable outcome for co-owners.
There are ways to prevent these outcomes. Co-tenants can agree to buy out the dissenting owner’s shares, or they can hire a mediator to help bring about a successful resolution. Despite the many benefits of TIC ownership, there are some potential drawbacks. Investors can consult legal counsel prior to participating in a Tenants In Common structure to better understand the benefits and any potential pitfalls they might face down the road.
What are the potential Risks of Tic ownership?
TIC properties can provide many appealing investment incentives, but there can be some drawbacks to the Tenant in Common arrangement as well. These include:
Common ownership and control
Major operating decisions about a TIC property must be unanimous among all owners. This could prove problematic if investors have different goals, objectives or viewpoints on how the property should be run and managed. Unanimous approval also is required for co-owners to sell or refinance the property, as well as sign new leases or hire new management.
Cost
The sponsor who packages and organizes the TIC will receive a percentage of investment funds for his or her efforts. Likewise with the licensed broker who sells TIC shares to the investor pool.
Investor limits
The 35-member cap on investors can exponentially increase the minimum equity required by co-owners, particularly for higher-quality assets that command premium pricing. However, since TIC shares can be owned in unequal proportions, key investors may decide to put up larger investments as it suits their investment strategies.
Financing
Since each co-owner is also a co-borrows on the property, financing can be difficult to obtain. Many lenders choose to pass on this ownership structure due to the complexity of paperwork involved.
Control
No single Tenants in Common investor in a given property owns it outright. If one co-owner has a lien or judgement filed, it could negatively impact other co-owners.
Illiquidity
While Tenant In Common interests can be sold, and you don’t need approval from other owners, there might be an agreement in place for right of refusal. Similarly, it might prove difficult to dispose of your interests due to a lack of potential buyers.