There are two ways to reinvest in replacement property: 1) The traditional approach, where the taxpayer directly buys a whole property; or 2) a second approach, where the taxpayer buys a tenant-in-common (TIC) interest in a larger property. This second approach is becoming more and more common, since it allows the "little guy" to participate passively in a large real estate venture.
What is a TIC Property?
When two or more taxpayers share ownership in a property they are usually "Tenants-In-Common". These taxpayers must directly own a fractionalized, undivided interest in the property. This means that each taxpayer receives a separate deed to the property, qualifies separately for non-recourse funding, etc. The taxpayers are tied together with a TIC agreement, which if structured properly, can preclude the IRS from re-characterizing the arrangement as a partnership.
TIC
Several companies have set up Tennant-In-Common programs for investors who fit some or all of the following criterion:
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They want to sell business or investment property and exchange into different property
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They would prefer a more passive role in the investment
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They want a good income from their investment (often 8 to 10% on their invested capital)
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They want the property to substantially appreciate in value
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They want to continue to be able to take depreciation on the investment
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They want the option to exchange into other property at some future date
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They want to identify a TIC property as a backup to their first or second choices for replacement properties
Here are more reasons why real estate investors may consider TIC programs
- They want the security of having a larger and perhaps more credit-worthy tenants backing the leases on their properties.
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They may believe that real estate values are better in other parts of the country.
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They may want to diversify and buy more than one property.
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They want more options in the type of property they purchase (such as a very conservative long-term lease to the US government, or a more risky renovation project in an urban area).
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They feel that they can get better management from the large management companies.
How does a Taxpayer get Involved with a TIC?
To accomplish a TIC investment, the taxpayer will first sell his relinquished property, and as in any other exchange the funds will be held in trust by the intermediary. During the 45-day identification period, the taxpayer would then meet with one or more of the reputable TIC sponsors (we are currently aware of five of them with long-term track records) to review the properties that are available. The taxpayer would then list one or more of them on his 45-day letter, and close on the undivided interest within the 180-day period.
It is important to note that many of these TICs are leveraged. Thus if a taxpayer has, for example, $200,000 of equity coming out of an exchange, it might purchase replacement property valued at $600,000.
How does a Taxpayer Exit from a TIC?
When taxpayer wants to exit from his TIC, he can sell his interest to another buyer. Alternatively, the TIC itself may sell the entire property. At this point, the taxpayer has several options: 1) He can receive the cash and pay the capital gains taxes at that time; 2) he can roll his proceeds into a new TIC property; 3) he can go back to the traditional approach and roll his proceeds into a whole property; or 4) if structured properly, he can roll his proceeds into an UPREIT.
What is an UPREIT?
The UPREIT concept is one where that taxpayer receives the benefits of REIT (real estate investment trust) shares, which are similar to mutual funds except a REIT owns several real estate properties instead of common stocks. The UPREIT strategy allows the taxpayer to earn monthly cash flow, and also allows the flexibility of partial liquidation of his investment. For example, if the taxpayer wants to pull $30,000 out of his UPREIT, he can do it instantly. Alternatively, since REIT shares are publicly traded, the taxpayer can borrow against the shares in the form of margin loans.