Tenant-in-Common/ Fractional Interest Exchanges

Completing a §1031 exchange with Tenant-in-Common interest ownership in a property, also known as co-ownership of real estate, allows investors not only to defer their capital gains taxes, but also to “upgrade” their investment real estate into larger properties.

IRS Revenue Procedure 2002-22, issued in April of 2002, is a development in the real estate industry that has many property investors excited. The clamor is due to a product that allows a small-time investor to acquire an interest in a large residential or commercial property, such as an apartment building or shopping center. Purchasing one of these “prime” properties was a luxury previously available only to developers and large conglomerates such as Real Estate Investment Trusts. Known as Tenant-in- Common (“TIC”) or Undivided Fractional Interest (“UFI”) property, it is quickly becoming a popular alternative to owning single-family rental property. Combined with an Internal Revenue Code Section 1031 (“IRC §1031”) tax-deferred exchange, this might be an option for those individuals wishing to escape the burdens of the real estate management business in favor of owning an interest in a high-grade property without all the typical administrative responsibilities. The IRS has finally established that tenancy-in-common ownership is eligible for nonrecognition treatment provided it is structured properly, such as by using a Qualified Intermediary.

TIC ownership is not a new concept. Property owners have been holding interests in real estate as tenants-in-common for well over one hundred years. Derived from English common law, a tenancy in common interest is a specific, undivided interest in a property with other co-owners. It is through this common ownership principle that the TIC industry was formed. Why is IRS Revenue Procedure 2002-22 (the “Procedure”) so important? For the years preceding its enactment, taxpayers exchanging into TIC products were concerned the IRS might rule that they were actually receiving an interest in a partnership. This would be a disastrous result since the Tax Code prohibits an exchange of partnership interests. An exchange for a TIC property that has IRS pre-approval or, at the very least, conforms to structure as stated in the Procedure, would now most likely ensure a valid exchange.

With the advent of the TIC industry, as bolstered by the Procedure, many property owners are now attempting to exchange their income and investment properties for fractional interests offered by TIC sponsors. Unfortunately, not every TIC offering will be structured properly to qualify under the Procedure and fewer still will actually be pre-approved by the IRS. Careful scrutiny of a prospective TIC arrangement and guidance of tax counsel must be used to ensure the viability of a fractional interest exchange.

This material is provided for informational purposes only and is not to be construed as tax advice. The reader is strongly advised to speak with a tax consultant before attempting to employ any of the concepts stated herin.