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How 1031 Exchange Tenant-in-Common Works

November 28, 2023

With the 1031 exchange strategy, you can postpone capital gains taxes when you reinvest the sale proceeds of an investment property into acquiring a replacement property. And with the Tenants in Common (TIC) structure, you can own a fraction of a large investment property with other investors. A 1031 exchange tenant-in-common is a strategy that allows you to combine these two strategies for a more profitable investment.

To stay compliant and minimize risks, you need expert guidance to successfully leverage the 1031 TIC exchange. That’s why you should consult with a reputable Qualified Intermediary (QI) before you start an exchange. You can contact us at Universal Pacific 1031 Exchange so we can guide you throughout the process.

In this article, you’ll learn how a 1031 TIC exchange works, common associated risks, and important factors to consider before making your choices.

What is the Tenants-In-Common 1031 Exchange?

What is the Tenants-In-Common 1031 Exchange?

A Tenants-in-Common (TIC) 1031 exchange is a real estate investment strategy that combines the benefits of a TIC ownership structure with the tax benefits of a 1031 exchange. In a TIC arrangement, multiple investors whether individuals or entities, collectively own a fractional interest in a property.

With fractional ownership, each co-owner, or tenant-in-common, has a distinct, undivided interest in the property. TIC structures are often used in commercial real estate investments where the cost of acquiring a property is high, and investors pool their resources to participate in fractional ownership.

Section 1031 of the Internal Revenue Code allows property owners to defer capital gain taxes when they exchange an investment property for another like-kind replacement property. This strategy is a powerful tool for real estate investors looking to postpone tax liabilities and potentially increase their investment portfolio.

Combining these concepts, a Tenants-in-Common 1031 exchange involves using the TIC ownership structure as a way to facilitate a tax-deferred exchange. But before that, you need to understand how it works to be sure you’re making the right decisions. Here’s how it typically works.

How Does The Tenants in Common 1031 Exchange Work?

How Does The Tenants in Common 1031 Exchange Work?

  • An investor sells their current investment property, known as the relinquished property.
  • Instead of directly acquiring a replacement property, the investor joins a TIC ownership group. With the TIC structure, they own a fractional interest with other investors in a larger property.
  • With the guidance of a sponsor or manager, the TIC group identifies and acquires a suitable replacement property. Each investor in the tenants in common structure holds a proportional ownership interest in the replacement property.
  • Leveraging the 1031 exchange, the investor can defer capital gain taxes that would have been due upon the sale of the relinquished property.

Common Risks Associated With TIC Investments

Understanding the risks inherent in investing in TICs and implementing proactive measures will help you feel more confident and make informed decisions when dealing with the investment. Here are some of the associated risks and strategies to minimize them.

1. Liquidity Risk

TIC investments often lack liquidity. So, it might be challenging to sell shares swiftly when necessary. To minimize this risk, understand the liquidity terms outlined in the co-ownership agreement. Consider the potential holding period and exit strategies. Diversify investments to include more liquid assets alongside TICs.

Common Risks Associated With TIC Investments

2. Property Performance

The performance of a real property within a TIC can fluctuate due to market changes or management issues. To tackle this, examine the property’s past performance and management methods. Also, collaborate with trusted property managers and choose well-established properties to reduce uncertainties about the property’s performance.

3. Lack of Control Over Asset Management

IC investors typically have limited control over the management and decision-making processes of the property. Major decisions may be made by a designated sponsor or manager. Consider investing in TICs where decisions are made collectively or those that provide investors with some voting rights. Thoroughly review the TIC agreement to understand the decision-making structure.

4. Market and Economic Risk

External factors like economic downturns or market fluctuations can impact the value of TIC investments. Diversifying your investment portfolio across various asset classes, evaluating the property’s resilience to economic shifts, and staying informed about market trends will help cushion against these risks.

5. Regulatory and Legal Risks

Changes in regulations or unforeseen legal issues can pose challenges to TIC investments. Have a legal counsel review your TIC agreements. You also need to stay updated on regulatory changes to help you stay compliant with legal requirements.

6. 1031 Exchange Risks

To maximize the tax benefits of a 1031 exchange, the exchange must follow the strict IRS timeline and rules. If you fails to identify or acquire a replacement property within the specified timeframe, you may lose the tax deferral benefits. It’s best to reach out to an experienced Qualified Intermediary (QI) to help you facilitate the exchange. Schedule an appointment with us at Universal Pacific 1031 Exchange let’s discuss your plans and help you initiate an exchange.

What are the Tax Benefits of TIC?

What are the Tax Benefits of TIC?

A 1031 exchange with TIC offers significant tax advantages for property owners looking to exchange one or multiple properties. Here are some of the notable tax benefits of this strategy.

1. Capital Gains Tax Deferral

Executing the 1031 exchange in TIC structure allows investors to defer tax when they sell an investment property and reinvest the proceed into a like-kind replacement property. By deferring tax, you get to accumulate more capital for investments.

2. Wealth Accumulation and Portfolio Diversification

Through 1031 TIC exchanges, investors can continuously defer taxes by reinvesting in new properties. That way, they accumulate more capital for investment, allowing for potential long-term growth.

In the event of an investor’s passing away, 1031 TIC exchanges can provide potential benefits for their heirs. Upon inheritance, the heirs may receive a stepped-up basis, reducing the tax burden if they choose to sell the inherited property.

For example, assume you inherit a TIC property acquired through a 1031 exchange. The property’s basis is “stepped up” to its current fair market value (FMV) at the time of inheritance, potentially reducing future capital gains taxes if you decide to sell the property.

What Properties Qualify for TIC 1031 Exchange?

TIC investments allow investors to invest in a wide range of property types based on their investment objectives and preferences. They  include:

  • Commercial Real Estate – office buildings, shopping centers, warehouses, and industrial properties.
  • Residential Real Estate – apartment complexes, condominiums, and single-family homes.
  • Vacant Land – parcels of land held for investment or development purposes.
  • Mixed-Use Properties – a combination of residential and commercial spaces within a single property.
  • Specialized Properties – hospitality (hotels, resorts), healthcare (hospitals, medical centers), or educational facilities.

Factors to Consider Before Choosing TIC Investments

Factors to Consider Before Choosing TIC Investments

Careful assessment of property quality, market value, and investment potential is crucial before considering TIC investment to mitigate risks and make informed investment choices. To achieve this, consider these key factors:

1. Quality Assessment

Evaluate the property’s structural integrity, maintenance needs, and necessary repairs or renovations. Ensure compliance with local zoning laws, building codes, and environmental regulations.

2. Market Value Analysis

Conduct a Comparative Market Analysis (CMA) by comparing similar properties in the area to evaluate market trends, pricing, and property values. Additionally, conduct professional appraisals to determine fair market value and validate pricing.

3. Investment Potential

Assess the property’s location for accessibility, nearby amenities, and growth potential. Analyze your rental income versus expenses for cash flow. Also, research market conditions, including property demand and factors affecting potential appreciation or depreciation.

4. Thorough Research

Conduct thorough legal due diligence, including property title searches and lease agreements, and assess any legal encumbrances. Additionally, you’ll need to review financial statements, operating expenses, and historical performance data for comprehensive financial analysis.

5. Professional Guidance

Consult experts and seek advice from real estate professionals, appraisers, legal advisors, and qualified intermediaries to guide investment decisions. With over 32 years of experience, our experts at Universal Pacific 1031 Exchange are always available to help you execute a successful and compliant 1031 exchange. From identifying potential replacement properties to filing your tax return, you can get the best solution to your challenges by booking an appointment with us. Call us on (866) 469-0809 to get started

Securing Financing for TIC Properties

Securing loans for Tenants-in-Common (TIC) properties may pose some challenges. Traditional lenders may hesitate due to issues with decision-making, shared liabilities, and foreclosure difficulties in case of defaults. Thus, obtaining TIC property financing often requires specialized approaches compared to standard real estate transactions.

To overcome these financing challenges, prepare a transparent package with detailed financial data, clear TIC management agreement outlining co-owners roles, and a strong business plan showcasing the property’s potential. You should also network with real estate professionals and seek specialized lenders familiar with TIC arrangements to gain valuable insights and better loan prospects.

TIC Contracts and What Investors Need to Know

In TIC investments, contracts are like roadmaps shaping how co-owners work together. These contracts detail who makes decisions, how responsibilities are shared, and ways to solve disagreements. Understanding these terms is crucial as they define how the property is managed and what it means for your investment in the long run.

When diving into TIC investments, it’s vital to negotiate contracts that suit your needs. Go for flexibility by including clauses that allow adjustments if situations change unexpectedly. Make sure to discuss clear exit plans like selling your share or buying out others if needed. Seeking legal advice can be a great help in understanding and tweaking these terms to match your investment goals.

Conclusion

A successful Tenancy in Common 1031 exchange requires thorough research, careful considerations, and informed decisions. You need to understand the basics of shared ownership, contractual obligations, and the potential financing challenges you may face. Also, you need to be sure that your transactions comply with the strict 1031 exchange timelines and other IRS requirements to qualify for tax deferral.

At Universal Pacific, we understand that finding your way around TIC investment with 1031 exchange can be overwhelming. That’s why we’re here to provide you with excellent QI services and expert guidance on how to achieve a smooth and compliant exchange. Reach out to us today to start an exchange.

About The Author

Michael Bergman, CPA
Michael Bergman is a California licensed CPA and Real Estate Broker with over 32 years of experience in commercial real estate. Specializing in 1031 tax-deferred exchanges and financial oversight, his expertise is invaluable for complex real estate transactions. Michael’s unique blend of financial acumen and real estate knowledge positions him as a trusted advisor in the industry, offering sound advice and strategic insights for successful property management and investment.

Don’t let taxes hinder your property investment decisions. Connect with us today for a free, no-obligation 1031 exchange consultation. Let us help you navigate the process with ease.