Can Tenants-in-Common Do a 1031 Exchange?

Real estate investments provide a way to diversify your investment portfolio, but you may worry about having enough funds available to purchase real estate investment properties on your own. If this is a concern for you, you may consider purchasing investment properties by using a tenants-in-common agreement. It can allow you to invest in properties with others while still allowing owners to seek deferral of capital gain taxes through 1031 exchanges.

What Is the Tenants-in-Common Structure?

The tenants-in-common (TIC) structure is a legal arrangement that allows two or more individuals to share commercial or residential property ownership. The shares of their ownership can be any size; they do not need to be equal amounts like in a joint partnership. Any income created by the property is divided among TIC members by ownership percentage or another specified agreement.

Tenancy-in-common agreements can be formed at any time. You do not need to have an agreement in place before purchasing your property. An individual can decide to form a TIC agreement and bring other people in to become part owners of a property they’ve owned for years.

TIC members can also divide their own share and distribute a percentage of their ownership to another. This includes giving existing TIC members greater shares in the property or bringing in additional owners from the original agreement. Each owner retains rights over their percentage of the property and can transfer their ownership to others during their life and through their will.

How Tenants-in-Common Is Different

Unlike joint tenancy, TIC shares are not transferred to the other owners after their death. Instead, their ownership percentage is transferred to their named beneficiaries or estate. Members of the TIC are also allowed to sell parts or all of their ownership rights to another at any time. Without breaking the initial agreement, TIC members can be added or removed, leaving the structure in place.

The degree of ownership in the TIC structure is another key difference. While all TIC members share equal interests and privileges of the property, their percentage of ownership determines how much they’ll profit from the property. Profits are not distributed equally among the members.

For example, if member A owns 50% of the property, while members B and C each own 25%, the profits from their property must be split between the percentage of ownership. If your property earns $10,000 from rental income per month, member A would receive $5,000 and members B and C would each receive $2,500.

Can Tenant-in-Common Do 1031 Exchanges?

Yes, tenants-in-common investments are viewed as direct ownership, making them eligible for 1031 exchanges. These exchanges allow investors to defer paying capital gains taxes on the profits from their properties. TICs must meet certain requirements, including that investors must receive deeds for their percentage of ownership instead of partnership shares.

Your TIC must also meet IRS standards such as:

  •       The number of owners not exceeding 35
  •       Members must have ownership of property for at least 6 months before interests can be sold
  •       The structure must have proportionate distribution of profits and share of debts and losses

All members of the TIC must agree to the terms of the deal for the exchange to occur. You won’t be able to defer capital gain tax through a 1031 exchange if members have different opinions or don’t agree to all sections of the proposed exchange.

 

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure. Cash flow or income are not guaranteed. Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. Diversification does not guarantee a profit or protect against a loss in a declining market.  It is a method used to help manage investment risk.

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