Tenant-in-Common Investing: A Replacement Property Solution
January 30, 2017
As individual investors embrace the benefits of real estate ownership, many have done so in various forms, including Tenant-in-Common investing. Everything from residential rental properties to raw land, apartment buildings and small strip centers. The common denominator in most forms of real estate ownership for the individual investor is that except perhaps for the raw land, all other forms of real estate ownership have been incredibly management intensive. While the benefits of ownership include in most cases some income, various tax shelters and a pride in ownership, the catalyst driving a sale of a property goes beyond general appreciation of an asset. All too often the biggest driver of real estate disposition is the lack of desire to continue to manage an asset. Typically, residential rental owners have been unable to justify the headaches of management with the levels of income they are able to produce on a month-to-month basis.
Historically, on the institutional investing side, individual owners were able to “buy” some tax advantages to off-set gains in other areas of an investment portfolio with tax shelters garnered from Limited Partnership Units. Following the Tax Reform Act of 1986, many of the shelters afforded to individual investors in Limited Partnership were eliminated. For real estate owners, this had little noticeable impact, but for institutional investment real estate firms this caused a lot of heartache in their ability to package their investment properties. Even though the wrapper changed, it did not change their abilities to acquire quality assets the Main Street investors lack the capital to buy.
Several years later, as more and more individual real estate owners became weary of continuing to manage their holdings for the level of income they were receiving there was a huge surge in 1031 exchange activity. The problem that faced many investors was “do I exchange for the sake of deferring and manage another labor-intensive property or do I cash out?” At the time, capital gain rates were still at 20% and investors still had depreciation recapture and state taxes where applicable.
About the same time institutional firms began investigating how they could provide a fractional ownership interest in a larger piece of property and provide it to the exchange client for investment. This was unmapped terrain. It was already known that Limited Partnership Interests did not comply for exchange purposes, and exchangers knew that for them to defer the taxes they needed to maintain real property ownership and a level of control. Thus, the Tenants-in-Common industry was born.
Based on British common law, tenants-in-common is a way for multiple people to register an account or investment. For purposes of replacement property, it is a way for multiple owners to hold title to an undivided fractional interest in a larger commercial property. In a nutshell, the Sponsor Company or Underwriter locates a property, their pro-rata share of any debt in the property and hold title to the interest. The sponsor company then enters into a management agreement with the investor and has now provided a turn-key replacement property solution.
What is a TIC Property?
A TIC property is a property generally of institutional quality that the investor may not have the capital or access to acquire where instead they acquire an undivided fractional interest. A Tenant-in-Common (TIC) program is professionally managed, and where necessary acquired with institutional level financing that an investor assumes on a non-recourse basis. Additionally, provided that the sponsor company follows the guidelines established by the Internal Revenue Service and outlined in March of 2002 with IRS Revenue Procedure 2002-22 your investment may be 1031 eligible for the deferral of capital gain and depreciation recapture liabilities.
Owners with highly appreciated assets who are facing a large taxable liability should they cash out (but want to take advantage of their current appreciation), and are unsure of what comparable asset they could acquire with the proceeds may be interested. The inverse is true for owners who have fully depreciated their asset. One of the benefits of real estate ownership is the partial sheltering of income through depreciation. Once an asset is fully depreciated, the owner no longer has the ability for that shelter, making a greater amount of their current income taxable.
Owners looking to eliminate the management intensive functions of real estate ownership, commonly known as the 3 T’s, tenants, toilets and trash may also benefit from a turn-key real estate approach.
Owners needing to diversify their holdings can benefit from selling one asset in one class and acquiring smaller fractional interests in multiple asset classes. This diversification can help to lower the overall risk in an investment portfolio.
Benefits to TIC Ownership1
As a real property owner in a Tenant-in-Common program, investors should be able to reasonably expect a few benefits to ownership. It is not unreasonable to expect a higher return given the increased grade of the real estate. Many TIC owners are entering this marketplace after having owned smaller rental properties. If the investor has already owned smaller commercial properties they may see comparable returns, all be it with lower risk based on grade of the asset.
Eliminate those pesky 3 T’s. Tenant-in-Common programs are professionally managed under a management agreement investors approve annually. No more ruined family holidays or vacations to take care of problems at the rental.
Most companies offer monthly income to investors. In most cases this income is predictable. Not withstanding general real estate risks, if the sponsor company has underwritten a program properly, they should have a reasonable picture of the cash and expenses for a property over the next 5 to 7 or 10 years.
Lastly, one of the strongest benefits to investors as a real property owner are the tax advantages received. First, investors have deferred the capital gains and depreciation recapture liabilities, but also for estate planning purposes, this asset can be left to the investor’s estate upon death with a step-up in basis eliminating the original capital gains liabilities altogether. Also, as a real property owner, investors will receive their pro-rata share of the depreciation from a property and if debt was placed on the property the pro-rata share of the interest from the first mortgage. Combining these components, investors can now shelter part of the income you receive creating a larger effective yield on your investment.
Related post: Knowing Your 1031 Exchange Tax Deductions
Internal Revenue Code Section 1031 allows for real estate owners to maximize their appreciation potential through the deferral of immediate tax liabilities upon disposition. This valuable section of the Internal Revenue Code can afford investors the opportunity to continually keep their dollars to work, allowing for further diversification and management of risks. Tenant-in-Common as a replacement property solution, can aide in the ease of doing business, increase the grade of assets bought, meet current income needs and future accumulation of wealth. It is important to note that as with any real estate transaction, Tenant-in-Common investing has its own substantial risks, not the least of which is the general illiquidity of the investment. While it can be proven that this illiquidity has aided in the protection of wealth in a properly diversified portfolio, these investment vehicles are not recommended for investors who do not have sufficient avenues of liquid capital.
1031 RPS offers the opportunity to invest in each of these categories. If you would like to speak to someone to discuss your personal needs and portfolio, give us a call at (844) 4RPS – 1031. Sign up for a free account to view our current inventory.
1Please note: 1031RPS.com and its associated personnel are not tax professionals, and they recommend investors consult with their tax advisor to ensure their 1031 Exchange is within the IRS guidelines established.