Reprinted from the issue of May 9th, 2005
BANKER & TRADESMAN
THE REAL ESTATE, BANKING AND COMMERCIAL WEEKLY FOR MASSACHUSETTS ESTABLISHED 1872
C O M M E N TA R Y
Versatility, Speed Make Tenant-in-Common
Structures Attractive
By John G. Balboni and date of the original
sale. Thus, to get the
Robert J. LeDuc benefit of Section
T
ENANT-IN-COMMON, OR TIC, STRUCTURES 1031 tax deferral,
for real estate transactions are one of real estate investors
the hottest products within the real must beat the clock
estate industry, causing nothing short of an when trying to locate
explosion in new business activity. The driv- (and close on) re-
ing factor behind this phenomenon is that placement assets
the TIC structure uniquely serves the needs that make economic
of many buyers and sellers of real estate. sense.
The demand for TIC interests is growing A TIC interest
rapidly both nationally and locally and, can offer a solution
while such deals are more prevalent on the to both the timing
West Coast, TIC structures are moving east. challenges to com-
Fortunately, the barriers to entry with re- plete the exchange JOHN G. BALBONI R O B E R T J. L E D U C
gard to selling this product are not overly and the need to find (jbalboni@sandw.com) is a (rleduc@sandw.com) is an
burdensome, provided certain tax and secu- a suitable invest- partner at Sullivan & Worcester associate in the Tax
rities law guidelines are kept in mind. ment. TICs are often LLP’s Real Estate and Corporate Department at Sullivan &
The origin of this product is found in the sold as part of a pre- practice groups in Boston. Worcester LLP in Boston.
Tax Code. Specifically, in order to complete a packed investment
tax-free Section 1031 exchange, suitable “re- and can be identified and purchased on a Sponsors, or the “sell-side,” of such deals
placement property” must be obtained. Re- much faster timeline than other types of fee are positioning their assets to meet investor
cently, the Internal Revenue Service issued ownership. In addition, the value of TIC in- demand. This translates into many real es-
guidance that a properly structured TIC inter- terests can generally be matched more eas- tate holdings being restructured to allow for
est can serve as such replacement property. ily to the amount of gain a seller wishes to the sale of fractional interests in accor-
The result of this guidance is that billions shelter in a Section 1031 exchange. dance with current tax rules. TIC sponsors
of dollars in TIC interests have been sold as TIC interests are typically of a higher qual- are willing to adjust their traditional think-
“replacement property” to investors looking ity and value than the realty previously owned ing on the sale of their assets because sell-
to defer gains from other real estate in Sec- by the buyer, and without day-to-day manage- ers obtain benefits in TIC deals as well. For
tion 1031 exchanges. This “Section 1031 ment responsibilities. TIC investors, by pool- example, TIC sponsors typically realize a
money” is at the heart of virtually all TIC ing their funds with other similar investors, higher price for their property than they
deals. As described above, Section 1031 of the typically “buy up” into a better asset class would have obtained in a straight sale to a
Tax Code allows a seller of realty to defer than otherwise obtainable by any one of them third-party buyer. The market also allows
gains from the sale by completing a Section alone. In the typical TIC arrangement, spon- sponsors to charge fees for “arranging” the
1031 exchange, by (very generally speaking) sors are selling undivided portions of high- deal and any related debt financing. In ap-
purchasing a new property with the proceeds quality, triple-net-leased buildings or large- propriate cases, the sponsor will enjoy con-
from the sale of currently held property. scale retail or office buildings that would have tinuing fees (often related to asset and
Time plays a critical role in completing a formerly been out of reach to the investor. Fi- property management) from the property
successful Section 1031 exchange transac- nally, TIC interests allow geographic and busi- even though he has little or no ownership
tion. The “replacement” or new property ness segment diversity. For example, a mod- thereof, as they retain the active manage-
must generally be identified within 45 days of erately valuable apartment building in Boston ment functions of the asset. Last, where
the disposition of the original asset and, once could be exchanged for TIC interests in a sin- sponsors master-lease the entire asset from
identified, the “replacement” property must gle-tenant Denver office building, a Los Ange- the TIC interest holders (and then lease the
typically be purchased within 180 days of the les shopping mall and a Miami storage facility. continued on page 2
2 B A N K E R & T R A D E S M A N M AY 9, 2005
property to subtenants), the sponsor may holder of a TIC interest must generally hold “active business” activities typically cannot
be able to participate in the long-term in- title to the underlying realty either directly be performed by TIC holders.
come stream from the property (TIC inter- or through a “disregarded entity” such as a The prevailing market view is that TIC in-
est holders typically benefit from a master- wholly owned limited liability company. terests – even though treated for tax pur-
lease structure in that the master lessee • There can be no more than 35 TIC inter- poses as real estate – are a security. There-
usually guarantees a certain minimum level est holders, with certain exceptions for fore, the sale of TIC interests should comply
of rents). married couples and persons who inherit with (or rely on an exemption from) applica-
partial interests. ble securities laws. These securities laws re-
Limitations and Requirements • Any debt encumbering the property quirements include, but are not limited to,
A properly structured TIC investment must be borne proportionally by the TIC in- selling such interests through a broker-
(from both the buy-side and the sell-side) terest holders, and the profits and losses dealer, offering the TIC interests only to ac-
must conform to several technical require- from the property must be likewise shared credited investors and providing proper dis-
ments. While a comprehensive discussion proportionally. closure of the TIC investment’s risks.
regarding structuring issues is well beyond • A holder of a TIC interest may grant an The TIC product offers major advantages to
the scope of this article, potential TIC spon- option for a third party to purchase the TIC both property owners and prospective pur-
sors should keep the following limitations interest, but the option price must be fair- chasers. While TIC deals must be structured
in mind: market value at the time of exercise. with numerous tax and securities law guide-
• Owners of TIC interests will enter into • TIC interest holders must limit their ac- lines in mind, these requirements have not pre-
a tenancy-in-common agreement governing tivities to those customarily performed in cluded exponential growth in TIC investments
their rights and responsibilities with respect connection with the maintenance and repair and it seems likely this trend to continue, if
to the property and each other. • Each of rental real estate; development or other not accelerate, in the near term. ■
Reprinted with permission of Banker & Tradesman.
This document may constitute advertising under the rules of the Supreme Judicial Court of Massachusetts.