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Tenancy in Common (TIC) - Nerd Alert Deep Dive π
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"Life get's complicated when you use other people's money to make money." Today, we're jamming on a wrinkle that tax preparers will often come across in real estate - using a Tenancy in Common (TIC) structure to keep a Β§1031 like-kind exchange in tact. ποΈ β‘οΈ π I've done another post on TICs and their restrictions previously here - so today will be more theory. What's a TICThe best way to think about a TIC is that's it's like a Joint Venture (JV) for real estate. π€ They are a workaround to a Β§1031 exchange when all partners are not aligned on the plan (some want to sell and some want to roll the proceeds into a new property). While TICs usually keep their own set of books, the TIC itself does not file a separate tax return. Instead, the individual owners of TIC interests (expressed usually in %s) report their share of TIC activity on their tax return. An example:
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A rental real estate property is owned 70/30 in a two member TIC.
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The property produces $1,000,000 in rent revenue, $900,000 of rental expenses, for a total net of $100,000 of taxable income.
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The 70% TIC owner is a person, so reports on his Schedule E (1040): $700,000 rent revenue, $630,000 of rental expense, for a total of $70,000 of taxable income.
β How They're Typically Used πππCalling a spade a spade - TICs are often used inappropriately. If you follow me, you'll know I preach that one of the foundations of tax planning is that Business Purpose > Tax Purpose. You can't expect the IRS to respect exotic structures that result in tax benefits for which there is no real business purpose. It's the same with TICs. TICs are most commonly used in "drop and swap" transactions that flow something like this:
The primary motivation for the "drop and swap" with a TIC is to convert an interest in a partnership (not 1031 eligible) into an interest in a TIC (yes 1031 eligible). That violates the foundation above. Rather than requiring a "holding period," the IRS wants to see that the TIC structure was not a part of a larger plan. π Interestingly, there is actually a box on a partnership tax return that asks if TIC interests were distributed (step #2 above): β Court Cases and PrecedentThe bar to beat is Chase v. Commissioner in 1989. π¨ββοΈ Here, partners that owned an apartment complex in the late 1970s looked to defer gain on a sale via an "undivided interest." The problem is that they were dealing with potential buyers, brokers, and agents within the partnership - while structuring the sale as a drop and swap. To the court, this looked like an "overarching plan of sale" of partnership assets - violating the requirement to "hold for sale" that is required for a Β§1031 purchase to stay compliant. It attributed the sale of the asset to the partnership instead of the TIC - and blew up the eligibility for exchange. Other cases exist where property that was sold into a 1031 was disposed of shortly after the replacement acquisition - but those facts indicated that the disposal shortly after the new property was acquired was not foreseen. The lesson is to plan ahead and again, keep business motivation one step ahead of tax. πΆββοΈ β Making money with other people's money works well when incentives are aligned and everyone is on the same page. A TIC is a useful tool to achieve different outcomes for partners - but it's not a slam dunk option. Know how to plan ahead if you're thinking this is for you. π«‘ π₯ Hottest Finance Posts This Week π₯
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