Will the IRS uphold your tenancy-in-common structure?

Posted on Mar 20, 2014 in IRS News and Updates · Real Estate

By Amber Busch, CPA

Tenancy in common (TIC) is an ownership arrangement in which two or more parties jointly own property, and title is held individually to the extent of each party’s interest.

Unlike a partnership interest, TIC interest, can be exchanged in a tax deferred exchange. The validity of the TIC status is imperative to preserve the like-kind exchange. Even in situations where the taxpayer did not enter the TIC through a like-kind exchange, they may desire to preserve the TIC status for future like-kind exchanges.

TIC’s need to be very careful not to go beyond mere co-ownership of property to the point of engaging in business together. The IRS has laid out fifteen factors, by not meeting these factors your business structure could be reclassified as a business entity by the IRS rather than a TIC. These factors provide a good set of guidelines for taxpayers as they set up and navigate their TIC arrangements. Each individual situation needs to be assessed based on their specific facts and circumstances.

Each co-owner must hold title as a tenant-in-common under local law.
The number of co-owners must be limited to no more than 35 persons.
The co-ownership may not:
1. file a partnership or corporate tax return,
2. conduct business under a common name,
3. execute an agreement identifying any or all of the co-owners as partners, shareholders or members of a business entity.
The co-owners may enter into a limited co-ownership agreement that may run with the land. These agreements may provide that a co-owner must offer its interest for sale to another co-owner at fair market value before exercising any right to partition.
The co-owners must unanimously approve:
1. The hiring of any manager,
2. The sale or other disposition of the property,
3. Any leases of the property,
4. The creation or modification of a blanket lien.
Each co-owner must have the right to transfer, partition and encumber the co-owner’s undivided interest without the agreement of any person.
Upon the sale of the property, the net proceeds (after payment of liabilities) must be distributed to the co-owners.
Each co-owner must proportionally share in all revenues and costs generated by the property and all costs associated with the property pro-rata.
Each co-owner must share in all debt secured by blanket liens on the property.
A co-owner may issue an option to purchase its TIC interest, as long as the exercise price reflects the fair market value.
The co-owners activities must be limited to those customarily performed in connection with the maintenance and repair of rental real property.
The co-owners may enter into management or brokerage agreements, which must be renewable no less frequently than annually.
All leases must be bona fide leases for federal tax purposes. Rent must reflect the fair market value of the property.
The lender may not be a related person.
The amount of any payments to the sponsor must reflect the fair market value of the acquired co-ownership interest and may not depend on the income or profits derived from the property.

The proper recordkeeping for a TIC is imperative to protect against adverse legal consequences from TIC owners, in the event of failure of the investment. In addition, maintaining proper records is important in preserving the TIC status with the IRS. Often we see TIC’s that are accounting for the activity more in line with a business entity, rather than a proper TIC.

A manager will generally be used to manage the activities of the property. However, there are some key items to take note of regarding the role of the manager. The manager must disburse to the co-owners their shares of net revenues within 3 months from the date of receipt of those revenues. The management agreement may authorize the manager to do the following:

maintain a common bank account;
prepare statements for the co-owners showing their shares of revenue and costs from the property;
obtain or modify insurance on the property; and
negotiate modifications of the terms of any lease or any indebtedness encumbering the property, subject to the approval of the co-owners.

Management fees must not depend on income or profits derived from the Property and may not exceed the fair market value of the manager’s services. Any fee paid by the co-ownership to a broker must be comparable to fees paid by unrelated parties to brokers for similar services.

As you can see, the TIC rules can be fairly complex and the validity of the TIC status is important to maintain if your goal is to defer gain recognition through a like-kind exchange. If you currently own property through a tenancy in common, make sure to discuss the ownership structure with your tax advisor to ensure that you are staying within the guidelines provided by the IRS. If you are considering entering into a TIC structure, call your tax advisor first so that you can discuss the rules and start the transaction off on the right foot. The team at Clark Nuber is happy to assist you with any questions you may have.

This article or blog contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.