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Thursday, Dec 7, 2023

Many Issues To Consider With Tenants In Common

I read with great interest the article written by Heather Bergman in the May 2 San Diego Business Journal on tenancy in common.

This is not intended to be critical of TICs, but instead to make people aware that the TIC structure involves a number of issues that must be addressed before investing.

– Revenue Procedure 2002-22 has at least 15 requirements that must be met in order for a taxpayer to fall within the safe harbor rules. Investors should not assume that the tenancy in common agreement under which they are investing has satisfied all of these requirements.

– Legal opinions. Determine whether the legal opinion that normally accompanies the TIC covers all of the matters that are addressed in Revenue Procedure 2002-22.

– Tenancy in common agreement. The investor needs to have their legal counsel review the tenancy in common agreement to ensure that the particular investor’s rights are adequately protected.

– Unknown tenants in common. One is going to most likely end up in a TIC relationship with unknown investors, possibly as many as 35. Depending on the rights provided for in the tenancy in common agreement, this can be a problem when it comes to voting.

– Lack of effective management. Any investors considering moving into a TIC relationship most likely control their property that they traded out of and they are now entering into a tenancy in common agreement where in most cases they will not individually have a controlling vote in many of or all matters surrounding the property.

– Purchase price of the property. There are some TIC sponsors who do not sell the TIC property to the TIC pursuant to an appraisal and do not, in fact, allow the investor to know the price at which the sponsor purchased the property for resale to the TIC investors.

– Guaranteed returned to the investors. In some of the TIC arrangements, there is a guaranteed return on investment to the investors. One needs to look closely at the quality of the guarantee that is being provided, which is largely dependent upon the financial ability of the guarantor who has multiple guarantees to other TICs.

– The location of the real estate. Many of these TIC properties are located in states in which neither the perspective tenant in common nor the promoter is physically located. There are obviously substantial issues when one is and/or attempts to own and manage out of state property in a market with which they are not familiar.

– Financing on the TIC property. Many of these TIC relationships are assembled hurriedly. Many of the TIC properties are in the process of being financed by the sponsor as part of the acquisition package and the investors often are not aware of the final financing terms. All financing is different and no one should purchase a TIC without clearly understanding the underlying financing.

– Inspect the property. You or your independent agents need to physically inspect any property that you are considering acquiring.

– What is your investment worth after you make the purchase as a TIC interest? Assuming that you have purchased the TIC property for a pro-rata share of the fair market value of the entire property, it is clear that the value of your interest immediately after your purchase is worth 20 percent to 30 percent less therefore paid.

– Rights of partition. In order to have a valid tenancy in common, the tenants in common generally need to have a right of partition, which can only be eliminated if prohibited by the lender. If exercised, these rights of partition can cause substantial unexpected problems to the remaining tenants in common.

– Unanimous approval required for certain matters. Revenue Procedure 2002-22 requires that the co-owners be unanimous in their decision to do any of the following: any sale, lease or re-lease of a portion or all of the property, any negotiation or renegotiation of indebtedness secured by a blanket lien, the hiring of any manager, and the negotiation of the management contract.

Unanimity may be difficult to secure from totally unrelated parties that may be located throughout the United States or the world.

Richard Kintz is a partner in the San Diego office of Sheppard Mullin Richter & Hampton.


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