You and the T.I.C.’s (Tenants in Common, that is…)

Historically low interest rates and increased demand for real estate have pushed down capitalization rates resulting in higher valuation of most real estate assets. As a consequence, equity positions have ballooned and investors have found themselves considerably richer. Property-owners, flush with cash, can transfer their appreciated equity positions (currently held in depreciated assets with limited tax deductions left) into other assets owned by a Limited Liability Corporation (LLC). Investors can do so by becoming Tenants in Common under the LLC. The process (under Section 1031 of the Internal Revenue Code) is tax-free, and reaps the additional benefits of higher returns and drastically lower management demands.

If you are one of those lucky investors with appreciated property in your portfolio, you may have asked yourself the question: Is the Tenants in Common a good arrangement for me?

The answer is: “Maybe yes, maybe not.” Before making any drastic re-arrangements in your portfolio you should ask yourself some very personal questions as to how you look at properties and money, in general, and your time and life, in particular.

1) Can you let “the pilot do the flying”? Or, you prefer to micromanage: you must know every detail and spend long hours on and off the property doing things yourself (or arranging for somebody else to do them) because you are the one who knows best.

2) Do you mind paying capital-gain taxes upon sale? Or, you are happy to allow hard earned dollars find their way to the federal and state governments to the tune of 30% of any profits plus accelerated depreciation re-capture.

3) Are you looking for more bang from your buck? Or, you are satisfied with the current return on your investment: divide the actual money left in your pocket at the end of the year by how much equity you have in the property. In determining your true yield on equity, do not forget to include as an expense the value of all your services rendered. Your time is money.

4) Are you looking for larger tax deductions? Or, you are happy with your current level of in income taxes. Income taxes which will increase, as your depreciation is used up or already gone.

5) Do you wish to lower the risks of your investment? Or, you are comfortable with the business risks, vacancies, maintenance, scheduled repairs, other expenses (insurance, utilities, etc), physical obsolescence, demographic changes, etc. affecting your real estate assets.

6) Do you want more free time? Or, you are happy with the current time demands exerted upon you by your properties.

7) Would you like your tenants to pay for your expenses: real estate taxes, insurance, utilities, repairs and maintenance, etc. Or, you are a hands-on person cherishing the thought of first hand involvement at every point.

If your answers to these questions are mostly YES, you should look into T.I.C.’s as a viable alternative to improve your cash flow and the quality of your life. Conversely, if you answered NO to most of these questions, you probably relish the day to day demands and challenges of property management and enjoy the process over and above strictly financial considerations. T.I.C.’s may not be your cup of tea.

An appropriately chosen T.I.C. will increase your cash flow, transfer the burden of paying for expenses to the tenant, remove the chores of management and leasing, allow you more free time and provide you with more income tax deductions (and lower taxes). Combined with a 1031 Tax-Deferred exchange, a T.I.C. will also permit you to avoid paying capital gain taxes upon the sale of your assets as well as transfer you equity into another property (also tax-free) upon the sale of the T.I.C. or the sale of your individual interest, irrespective of the other owners desires and actions.

To summarize: a T.I.C. arrangement is a structure that allows a group of investors to pool their resources, utilize the services of a professional manager (while preserving the owners’ control on all major decisions), acquire institutional-size investment-grade property, perceive a net return (insurance, maintenance, real estate taxes paid directly by the tenant), finance at lower rates due to the higher credit worthiness of their accredited long-term tenant, and provide a larger depreciation base (lower income taxes due to higher deductions). To boot, investors may do all of that, without paying a penny in capital gain taxes to federal or state governments upon sale of their current asset and transfer of the equity into the new asset. They can exchange tax-free, again and again: upon the sale of the T.I.C. property or transfer their equity out of the LLC into another LLC or a stand alone property.

Written by:

Carlos A. Solares (MBA, CPA, Broker) has been involved in tax-free exchanges since 1978 when he managed International House of Pancakes, Inc. portfolio of over 200 properties. He organized his first Tenants in Common transaction in 1991 and his legal counsel was Ronald W. Lyster, Esq.