Common Interest

For real estate investors in the high-end property management game looking to sell buildings that have appreciated in value, and sidestep the capital gains tax, the arrival of the tenant-in-common (TIC) market must have seemed like manna from heaven. Section 1031 of the Internal Revenue Code has long allowed for a tax-free exchange of “like kind” properties that are held for “productive use in a trade or business or for investment” purposes. (As part of the legal term “tenant-in-common,” “tenant” refers to a joint owner or co-owner.)

Under that provision, investors might sell an office complex and reinvest the proceeds in an apartment building of equal or greater value, for example, or trade undeveloped land for an industrial   or retail property. To be able to defer the capital gains tax from those deals, TIC investors must identify a replacement property within 45 days of a sale, then close on that deal within 180 days.

"Those that got into TICs early have seen a lot of appreciation in their assets. But I think it will be harder to make money going forward."

But it wasn’t until a new IRS revenue procedure on Section 1031 was released in 2002 that the current TIC industry took flight. The procedure said individual investors can combine capital from real estate sales with as many as 35 other investors to acquire a new property and still defer capital gains taxation. The result was billions of dollars in equity flowing into new group-based TIC investments between 2002 and 2005.

Changes swept the industry in 2006, however, as the fledgling market began to show growing pains and the explosive growth leveled off. The appeal of the TIC investment is still strong, but real estate experts offer some caveats and advice for potential investors.

TIC deals appeal to high-net-worth investors on many levels. Beyond deferring capital gains tax, investors—typically in the 45 to 65 age range with a track record of successful real estate investing—have a chance to own a piece of a large commercial or retail property that might otherwise fall beyond their individual reach. For example, an investor might leverage a $200,000 investment and get a fractional interest in a property valued at more than $10 million. Each unit holder receives a prorated share of the property’s tax shelter, rental income, and property appreciation.

Organizations that identify TIC investment properties, acquire buildings (although the sale is made by a real estate broker or a licensed dealer, since deals are considered either securities or real estate investments), and then offer co-ownership interests to investors are called sponsors. These firms are responsible for collecting rent, providing maintenance, making capital improvements, and trouble-shooting problems such as key tenants leaving or repairing storm damage to buildings.