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Bite-size portions for investors

Tenants-in-common property transactions, which offer tax breaks, surge in popularity.

September 16, 2007|Tom Kelly | Special to The Times

Is the warm weather bringing out more TICs?

Unlike the pests that bother our pets, these TICs -- tenants-in-common agreements -- can be helpful options for investors.

Their popularity is due to the run-up in prices, said Tom Oldfield, a tax-deferred exchange specialist in Tacoma, Wash. "Sellers wanted to get out of one property and exchange into another but they found replacement property was far more expensive than what they could afford."

The answer for many taxpayers has been the TIC transaction. This strategy allows investors who sell a property to buy ownership interests in another property (or properties) instead of buying an entire "like-kind" property to qualify for an exchange and defer capital-gains taxes on the sale.

Although TICs have been around for years, they were officially blessed in 2002 when the Internal Revenue Service issued a set of 15 ground rules. Interest increased immediately, especially from investors who had no easy way of locating others who wanted -- or could only afford -- a piece of another property.

Here's how TICs usually work: A "sponsor" such as a real estate investor or broker will identify and arrange to purchase a building. The sponsor will then make available a TIC purchase opportunity to other investors through friends and brokers. These potential buyers can either buy a TIC interest outright or transfer the proceeds of a previous property sale in order to qualify as an exchange, which allows them to defer capital gains.

"Investors need to properly research any TIC offering and understand what they are accepting," Oldfield said. "They need to know how the property is going to be managed, and if the costs include a commission, which is typically paid by the seller, not the buyer."

Oldfield said that many TIC commercial buildings often are leased to one master tenant who is associated with the TIC sponsor. The master tenant then subleases the building and stands to profit the most when rental rates rise. Participants are guaranteed a rate of return.

A tax-deferred exchange (commonly known as IRS Section 1031 Exchange) is really an arms-length sale and purchase. Provided you closely follow the exchange rules, the IRS will "sanction" the transaction and allow you to characterize it as an exchange rather than as a sale. Thus, you are permitted to defer paying the capital gains tax.

An exchange occurs when you trade real property other than your home or second residence for other "like-kind" real property that you have held for trade, business or investment purposes. The like-kind definition is very broad.

Section 1031 specifically requires that one property must be exchanged for another property, rather than sold for cash. The exchange is what distinguishes a Section 1031 tax-deferred transaction from a sale and purchase. The exchange is created by using an intermediary (or exchange facilitator) and providing the required documentation.

By pooling the proceeds of investors, TICs combine the tax benefits available through 1031 exchanges with the potential advantages of owning a share of an investment property. Investors receive monthly distributions while giving up maintenance and administration chores.


Tom Kelly is co-author of "Cashing In on a Second Home in Central America."

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