Today we will be taking a pretty deep dive into an ownership structure common in real estate - the Tenancy in Common, or TIC. 🏢 This may be overly deep if you don't care about real estate tax structuring - but it's exactly the thing I nerd out 🥸 about and enjoy so it's what you get today!

Below, we'll talk about:

• What a TIC is and how it's used 🤷‍♂️
• What are the (lesser-known) rules to run a TIC for tax compliance 🔖
• What does tax filing look like for TIC and TIC owners 📄

🚨 Before we dive too deep - I want to remind you that I also run a podcast called Today in Tax Court where I review recent and landmark tax cases to better share how our tax system works. If you like podcasts and this newsletter, please give it a listen and share it. 🚨

What is a TIC?

A Tenancy in Common is essentially an agreement between people (or entities) to own and operate rental property. Unlike a partnership, 🙅‍♂️ however, the separate TIC owners are deemed to own individually an undivided part of the entire property. 🧑‍🤝‍🧑 Whereas in a partnership, it is the entity that owns the property 💼, in a TIC it's the "investor" or TIC owner that personally owns that % of the underlying property.

If this is confusing already, just wait. Only kidding. Below is an illustration that may help:

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In a partnership, each partner owns a set % of partnership (or LLC) units. That amount of ownership determines how much loss and income he is allocated - along with other factors, of course. 😉

Similarly, an owner of a TIC has a specific % of ownership in that TIC - which also drives how much income and loss he is allocated. But the TIC allocations, as we'll see, are much less flexible than a partnership. 💪

So why do TICs exist?

Simple answer really 👉 1031s 👈

For the uninitiated, a 1031 transaction is where owners of real estate may elect to defer the gain realized on the sale of a property by purchasing an equally or greater value property. 🌀 There are a lot of 1031 compliance rules we won't get into today. But one of them drives the use of TICs more than anything.

1031 transactions in partnerships require all partners to comply with deferring the gain. If you have some partners that want to defer and some that don't, it can kill the 1031. ⚰️

BUT, if instead of a partnership, the property is in a TIC, each TIC owner can decide separately without impacting other partners desire to 1031 or not. 🙏 This is because a TIC interest is considered real property and therefore when the underlying property of the TIC is sold it can be replaced via 1031 with another TIC in another property. 🔄

But there are some rules that must be followed.

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TIC Rules

The first rule to follow is more of a judgment call. A lot of times, partnerships will perform a "drop & swap" to essentially convert a rental real estate partnership into a TIC - which is quickly sold and 1031'd. This quick time frame of conversion to TIC and subsequent sale may give off vibes that the only reason it was done was for tax reasons. 😥

Like all other things in tax - the business motive must stay one step ahead of the tax motive. So the IRS likes to see a TIC operate as a TIC for a few years to substantiate it's business purpose. 📆

The second rule is really a set of rules. In 2002, the IRS released Rev Proc 2002-22 which laid out some very helpful guidelines for what it will consider a well structured TIC:

1. TIC Ownership - the TIC itself is not structured as a partnership but is owned truly separately under local law.
2. Number of TIC Owners ≤ 35 - you can't have more than 35 separate TIC owners.
3. No Treatment of Co-Ownership as Entity - not file single tax return, execute agreement as "partners"
4. Co-ownership Agreement - may have offer to purchase other co-owners interest at fair value.
5. Voting - hiring, disposition, creation of liens must be unanimous. Other items require >50% approval.
6. Restriction on Alienation - talk to an attorney
7. Sharing Proceeds and Liabilities Upon Sale - proceeds due to all co-owners.
8. Proportionate Sharing of Profits & Losses - each co-owner shares in profits & losses in proportion to co-owner's undivided interest.
9. Proportionate Sharing of Debt - what it sounds like.
10. Options - co-owners can have option on each others interests.
11. No Business Activities - the underlying activities must be rental real estate in nature.
12. Management and Brokerage Agreements - a co-owner may have these types of agreements so long as they are fair value.
13. Leasing Agreements - rent = FMV & cannot depend on income or profits derived by any person from the property leased.
14. Loan Agreements - lender cannot be related person to any co-owner, sponsor, manager, or lessee of the property.
15. Payments to Company - payments to sponsor for TIC interest must = FMV and not based on income or profits of the property.

That's a lot to digest - so please talk to an attorney for how this impacts you.

But one thing sticks out is #8. ⚠️ TICs differ from partnerships in income and loss sharing. If a sponsor is expecting a large promote or carried interest in a TIC deal, it may need some attention to structure properly.

Needless to say, TIC agreements should be analyzed and crafted with as much care as a partnership operating agreement.

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What Do TIC Tax Filings Look Like?

Because TICs do not file a partnership tax return (as we saw above in Rev Proc 2022-22 Rule #3), the ❗ TIC owners do not receive a K1❗

Instead, TIC owners must be provided a calculation of their share of the underlying assets, liabilities, income, and expenses of the property. 🤏

In practice, the accounting is done at the property level and a workpaper is provided to each TIC owner with that "100% TIC" activity multiplied by their % of TIC ownership. 🧮

That person, or entity, will then record that rental activity on their tax return as though it were a separate property they owned (because it kind of is).

So for an individual TIC owner, the TIC activity would go on their Schedule E Page 1 like a regular rental - and not on Schedule E Page 2 where K1s go. All rental income, depreciation, and operating expenses would be broken out instead of just one net number presented. 🫤

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If you made it to the bottom - color me impressed. 🫨 Not every email blast will be this technical, but I enjoy them from time to time. TICs particularly tripped me up early in my real estate career because there wasn't a lot of practical information widely available for how to treat them and advise clients with.

Here's to hoping this helped someone - have a great week ahead.

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