During the mid- to late-1990s, investors made numerous requests to the IRS asking for advance rulings as to whether an undivided (fractional), Tenants in Common interest in real property was an entity eligible for tax deferral under Section 1031.
In response, in October 2000, the IRS issued Revenue Procedure 2000-46. This procedure expressed concerns that some Tenants in Common relationships might be viewed as partnerships for federal tax purposes and therefore ineligible for 1031 consideration. The IRS made it clear that it would no longer issue any advance rulings. This decision was repealed in March of 2002, followed by Revenue Procedure 2002-22.
Known as the "Rev. Proc.," Revenue Procedure 2002-22 set out 15 points, which would be reviewed by the IRS when "considering a request for a ruling that an undivided fractional interest in rental real property is not an interest in a business entity" -- meaning a partnership that would not qualify could put the exchange at risk of an audit and tax consequences.
However, obtaining an advance ruling will still be nearly impossible. Much of the information required for an IRS review is not even available until the sponsor is ready to acquire the property, close the loan, and sell interests to the tenants in common. Hence the reason why most sponsors’ council issue a "should" or "will" tax opinion located in the Private Placement Memorandum.
Revenue Procedure Guidelines for Tenants in Common 1031 Exchanges
The Rev. Proc. established clear guidelines for the structure, financing and management of a Tenants in Common ownership. It allows 2 to 35 co-owners, although sponsors and lenders may set lower limits for some properties, which are usually between 10 and 25 investors.
A husband and wife are sometimes treated as a single entity (depending on state law) and none of the co-owners is allowed to file tax returns as a partnership. Each co-owner has the right to sell or partition his fractional ownership but only after offering it for sale to the others. There is a proportionate sharing of profits and also debt (mortgage).
With these clearer guidelines, the TIC industry began in earnest and attracted a larger number of new sponsors, broker / dealers and registered reps to the marketplace. Since the 1990s, there has been tremendous interest in Tenants in Common 1031 Exchanges. In fact, growth in equity has mushroomed 550% in TICs from 2002 to 2004. The total value of TIC investments that closed in 2007 is estimated to be over $8.5 billion. Some say this number is even higher -- reaching $10 billion (when including leverage).
Tenants in Common Offerings to Accredited Investors
The vast majority of TIC offerings are made to "accredited investors" only, which means that certain financial criteria must be met.
-
Single investors (or in combination with a spouse) must have a net worth greater than $1 million.
- An annual income of $200,000 the past 2 years with the anticipation that this will continue.
- A joint income with spouse of $300,000 over the past 2 years with the expectation of no change.
- An entity such as an LLC, Partnership or Corporation must have assets of at least $5 million or, if the assets are less than $5 million, each investor must be accredited as an individual.
