Group Real Estate Investing

LOS ANGELES (MarketWatch) -- Two years ago, Harriet Skarie and her family sold a labor-intensive 105-unit residential building for $8.725 million and paid tax on only half a million dollars of capital gains -- even though the tax basis in the property was about $5 million. She and her family were so delighted, they did it again with another property for similar tax savings. So what's the big deal? Section 1031 of the U.S. tax code allows anyone such tax-free exchanges or rollovers of "like-kind" income property. The Skaries did that, with a twist. Instead of chasing after another income property to buy and manage again, they rolled their money into TICs.



What's a TIC? Paula Straub, a financial adviser in Carlsbad, Calif., who operates the SaveGainsTax.blogspot.com explains that TIC -- Tenants in Common -- exchanges, allow you to sell your property and roll the proceeds over to shared property where you own a separate, tenant-in-common interest.



Many married couples will recognize the tenants in common designation as the way they hold title to their own homes. But in the investment arena TIC has been used as a way to own property without being hamstrung by your partners' refusal to sell when a good offer comes along, said William L. Abrams, of Abrams Garfinkel Margolis Bergson LLP. His firm has been arranging for tenant-in-common properties for their New York and California clients for well over a decade.



The strategy of rolling over 1031 exchanges into TIC properties is one that is gaining momentum today. Read about the pitfalls of TIC investing.



Dan L. Werry, managing director of 1031 & TIC Investments LLC in Minneapolis, is so excited about TICs that he's gathered every bit of research on the subject. Seeing the potential benefits to property owners, Weery has been helping people like the Skarie family sell their properties at peak market values and in the process overcome three problems property investors routinely face:

1. How to sell a property worth millions, but with a low tax basis, without losing all the appreciation to taxes. Weery and the Skarie family's CPA and real estate attorney, worked the TIC to pull out cash while keeping the taxes minimal, and to roll over the rest.
   
   
2. How to eliminate the strain of the time drain. Harriet Skarie used to devote her life to managing the family's residential properties, fielding calls from tenants and contractors all day long. Dan put them into commercial and industrial properties with building managers. Skarie is involved with all decisions, but not the day-to-day management. She's free to pursue her passions -- as a writer and artist.
   
   
3. How to diversity and reduce risk. Weery helped them find TIC deals in two hotels in Philadelphia, office buildings in Texas and Florida, a shopping plaza in Chicago and a warehouse in Minneapolis.
   
   

Are TICs safe rollovers for tax purposes?



There really isn't any specific guidance from IRS about whether or not they would permit 1031 exchanges to be rolled over into commonly owned properties. The watershed moment that made all this possible was the IRS's revenue procedure 2002-22 in March of 2002, says David S. Rachford, a certified public accountant and president of Rachford & Company, in Santa Barbara, Calif.



Rachford said the revenue procedure outlines the conditions the exchange transaction must meet in order to submit it to IRS for a private ruling. But, have you ever tried to get a private ruling from IRS, asks Mike Howlett, a certified public accountant and partner at Cherry, Bekaert & Holland in Virginia. It takes anywhere from six months, if you're lucky, to over two years.



But under the 1031 exchange rules, you only have 45 days to identify your replacement property or properties. And you must complete the sale within 180 days of selling the original property. That's simply not enough time for IRS to issue an opinion on your transaction. So, no one bothers to ask.



Learning that everyone is really running blind, you'd choose to avoid TICs, even if they can help you, rather than lose sleep worrying about IRS coming along and overturning your 1031 exchange. But should you?



We asked the IRS. "Since the industry is not getting the rulings, but they are following the conditions set by Rev Proc 2002-22, will IRS accept the exchanges as 'kosher'. Or will IRS object because the rulings weren't obtained in advance?"



IRS's spokeswoman Michelle Lamishaw said that the IRS will not automatically accept the exchanges as "kosher." The IRS would have to look at the facts and circumstances specific to each transaction before determining whether a particular transaction is "kosher." On the other hand, the transactions won't automatically be rejected for failure to get a ruling in advance; they just won't have the protection of having a ruling.



That could come as a relief to hundred of taxpayers as the TIC business booms. There were $98 million in transactions in 2004, according to the Sacramento, Calif.-based Tenant In Common Association and more than $2.25 billion so far in 2005, according to South Jordan, Utah-based Omni Brokerage Inc.



TIC pros



Tom Brenneke, president of Guardian Management, a Portland, Ore.-based property investment and management company that has closed 15 TIC deals worth about $150 million in the last two years, outlines some of the problems TIC exchanges solve, especially when it comes to the dealing with the rules surrounding 1031 exchanges:

• The desperation factor in finding a replacement property on time. Often, the replacement property you select ends up being unsuitable or unprofitable, once you've done your inspections and due diligence. Having a TIC, or several, among the replacement properties, you're not forced to accept a bad deal or pay too much just to avoid your taxes.
  
  
• Being able to roll into a TIC means aging owners, whose children don't want to take over, can finally give up managing older, declining properties.
  
  
• Avoiding family/partner squabbles. When family members or partners have different financial goals, they can each roll their share of the sale into TIC properties that meet their needs. One person may be more concerned about cash flow, while the other, often younger, may prefer properties that will appreciate rapidly.
  
  
• You can finally sell those properties you bought 50 years ago, with practically no basis but with high mortgages, because you've been pulling cash out all these years.
  
  

Rachford adds that when you own a building jointly, when you get an offer, all owners must be in unanimous agreement on the price and terms before you can sell. When you own a property under the Rev. Proc 2002-22 tenant-in-common rules, you can sell your share of the building to anyone you like without consulting your partners. Regular TIC contracts may require that you offer the other tenants the first right to make you an offer when you're ready to sell. Or that they must approve any new owners.



What do IRS rules require?

1. You hold title in your own name -- no entities. Exception is disregarded entities, like a single owner LLC or a living trust.
   
   
2. There can be no more than 35 owners of the property.
   
   
3. You can't act like an entity -- the building doesn't file partnership tax returns, or conduct business under a common name.
4. All contracts are executed by all owners.
   
   
5. A co-ownership agreement is permitted.
   
   
6. All major voting decisions must be unanimous regarding the sale of the entire building, hiring managers, refinancing and tenant leases. Minor decisions may require only a majority vote.
   
   
7. Each owner must have the right to sell or partition their share, even to mortgage it without the consent of any of the other tenants in common.
   
   
8. When the property is sold, any blanket liens must be paid off and the rest of the money split in proportion to ownership shares.
   
   
9. All profits and losses are split by ownership percentage, unlike partnerships and LLCs where partners may have different profit, loss and capital shares.
   
   
10. All owners share in mortgages and other debt placed on the whole building.
    
    
11. It is all right to offer your co-owners the option to buy your share before putting it on the market.
    
    
12. You can't turn this into a business, like a hotel. It has to follow the passive real estate rules.
    
    
13. Co-owners may enter into agreements with property managers and brokers. Rules of who may be hired are defined.
    
    
14. Leases must be bona fide, at fair market value, even if a co-owner leases the property.
    
    
15. In any loan agreement, the lender may not be related to any of the co-owners, sponsor, manager or lessee of the property.
    
    
16. Payments and fees to any sponsor, organizer or syndicator must be based on fair market value of the property, not based on any profits.
    
    
    
    
    
    TIC cons
    
    
    
    Have you ever tried to refinance a building with 35 owners? Dan Weery points out that each owner must produce their financial statements and tax returns. Some other problems:
    
    
    
    
    
    • When someone puts a mortgage on their own share of the building and defaults on it, it could conceivably put the whole building into foreclosure. Brenneke says this is rarely a problem because the primary mortgage lender's contract will have a clause forbidding any other mortgages without their consent.
      
      
    • It's easy to make errors in setting up TICs, or in the exchange of the properties. That especially true in situations where a partnership property was sold to buy the separate TIC properties.
      
      
    • Using TICs enables you to roll your exchange into properties in other states. But that could trigger state tax consequences. Get the advice of a professional, Abrams advises.
      
      
    • There is a question as to whether some of these 'sponsored' TIC arrangements are really securities, as opposed to real estate purchases. The industry is still trying to resolve this issue, since some of these investments are sold through securities dealers, according to Howlett.
      
      
    
    
    Finding a TIC property that you can purchase to meet a 1031 exchange deadline is easy, experts say. Apparently, somewhere in the country, there are several properties getting ready to close escrow every month.
    
    
    
    In fact, even if you're not seeking out a replacement property in a 1031 exchange, TICs could be an excellent way to invest in real estate without all the hassles of management, or the vagueness of REITs.
    
    
    
    Your financial or real estate advisers can help you locate TIC properties. Or take a look at the Web site of the Tenant In Common Association. You can find a member in your state, or the state where you want to own property.
    
    
    
    http://www.ticassoc.org/locator.asp />