Tenant in Common Definition
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What Does "Tenant In Common" Mean?
Multiple parties or investors own undivided fractional interests in a TIC property, either commercial or residential. Unlike joint tenancy, where each party owns an equal share based on the number of owners, owners of a tenant in common property may have unequal shares. For example, one owner could own 60%, with the remaining investors sharing in the balance.
Each owner of a tenant in common property receives a separate deed and title insurance for their share of the property. If the property is a tenant in common investment, each owner is entitled to a pro-rata share of net income, property appreciation, and depreciation.
Owners of a tenant in common property have the right to transfer their ownership and demand a partition of the property. They can also borrow against their ownership share. This way, a tenancy in common investment gives owners many of the same benefits as the sole owner of a property.
Investors can make TIC agreements at any time. For example, if Susan and Maria each own 50% of a tenant in common property, Susan can decide two years later to split her interest with three additional investors. Susan could keep a 20% share and sell 10% each to John, Jim, and Orlando.
There can be an unlimited number of owners in a tenant in common property unless used as a 1031 exchange. In this case, the number of owners is capped at 35.
Tenancy in common structures have become increasingly popular with real estate investors and real estate syndicators. They are also useful in tax-deferred 1031 exchanges; the IRS recently issued a ruling declaring TICs as a legitimate vehicle for a 1031 exchange.
Financing a Tenant In Common Property
Financing may be different depending on the location of the property. In some areas, lenders require the signature of all owners of a tenant in common property; the parties must take out the mortgage together. This way, the lender can foreclose on the property even if only one borrower defaults. Obviously, this arrangement carries more risk for other owners in the TIC property.
Meanwhile, other areas permit fractional mortgages. A fractional mortgage is secured by the individual owner’s share of the property; the other owners are not imperiled by a default. If a borrower defaults, the bank forecloses on and sells that person’s share, usually offering first rights of purchase to the other TIC owners.
On new projects, developers may also offer wraparound financing. With this type of financing, the developer obtains a loan secured by the entire property before the TIC is created. As new owners purchase interests, the developer extends individual loans. The developer collects payments from the partial owners and, in turn, pays the lender.
Property Taxes and Tenant In Common Properties
Most jurisdictions do not issue separate property tax bills for each owner; there is a single bill for the entire property. The TIC agreement usually specifies how property tax liability will be divided among the owners. Owners can deduct their share of property taxes from their income tax filings.
There is also the issue of joint-and-several liability for tenant in common properties. Under joint-and-several liability, each owner can be liable for the full amount of taxes due on the property, regardless of the percentage of ownership. Most jurisdictions stipulate joint-and-several liability on tenant in common property taxes.
Using Tenancy In Common for 1031 Exchanges
A TIC 1031 exchange can be attractive for several reasons. First, TICs allow for greater diversification as a single property can be exchanged for multiple tenant in common properties. This gives the investor the ability to expand into different property types and geographic areas.
Investors can also use TICs to access commercial and institutional-grade properties that may not otherwise be available to retail investors.
The latest IRS guidance on using tenant in common interests for a qualifying 1031 exchange includes the following:
- There can be no more than 35 TIC owners.
- The sponsor can only own the property for six months before 100% of the shares are sold.
- Owners should unanimously approve all material decisions that financially affect the property.
- The management agreement must be renewed each year and provide market-rate compensation.
TICs as Investments
Many syndicators offer tenant in common properties for investment. Buying into a TIC is a good way to own a higher quality asset than one might otherwise afford, but investors should keep several things in mind:
- Syndicators often manage TICs. They act as a layer between the investor and the property and tenants. The syndicate manages operations and sends a regular performance report and profit distribution.
- In some cases, the syndicate executes a master lease for the entire property and pays owners based on the terms of that lease. The syndicate is then free to keep the rent collected from tenants. If the market increases, the syndicate pockets a higher proportion of the profits, although the master lease can act as a buffer if the market declines.
- A minimum investment of $100,000 is typically required to buy into a TIC investment. However, investors will also have to meet the SEC requirements for a qualified investor since interest in a TIC qualifies as an unregistered security. This means investors must have a net worth of at least $1 million.
- Tenant in common investments can be extremely illiquid. The syndicators can restrict the investors’ ability to sell on their preferred timing. Also, most syndicate agreements include generous fees, which decrease the investors’ ultimate returns. The syndicate could also become insolvent and unable to meet its obligations to investors.
Understanding Tenant In Common Agreements
TIC agreements spell out the rights and responsibilities of all parties involved and provide detailed procedures for conflict resolution.
Generally, TIC agreements should address the following items:
- Permitted usage and usage assignment. This outlines each owner’s access to different areas of the property, including exclusive and group usage. It also describes any limitations on use, such as pets and the number of tenants.
- Ownership share. This describes the owner’s share of the property and calculates ownership shares, i.e., by contribution, square footage, or value.
- Property management and maintenance. This describes each owner’s responsibility for maintaining the property and whether any management or maintenance tasks will be contracted out to a third party. If the TIC is a 1031 exchange, IRS guidelines prohibit management fees that exceed fair market value or those based on a percentage of profits.
- Allocation of expenses. The agreement allocates property taxes, insurance, utilities, maintenance, repair expenses, and deductible expenses (such as mortgage interest) to each owner.
- Transfer of interest. There is no ban on selling ownership interest, but owners can insist on certain conditions in any transfer of interest. For example, the other owners may get right of first refusal when another decides to sell their share.
- Decision-making framework. The agreement may say, for example, that a simple majority can make decisions that affect day-to-day operations, a supermajority for expenditures over a certain dollar amount, and unanimous approval for major decisions. Note that in the case of a 1031 exchange, the IRS requires unanimous approval for all material decisions.
- Dispute resolution. This section should describe what constitutes a default and how to handle defaults and disputes, including mediation, arbitration, or litigation.
A tenant in common agreement gives each owner a separate deed and title insurance for their fractional share of the property. This means they can sell, transfer, or borrow against their share of the property, and a default by one owner does not affect the others. TICs can be used in 1031 exchanges to diversify into other types of assets and geographic locations.
Investors also use tenant in common agreements to get into a higher quality of asset than they might otherwise be unable to afford. However, a TIC has several drawbacks, specifically that it is illiquid and usually cannot be sold at will.
- Sember, B. (n.d.) Joint Tenancy vs. Tenants in Common. LegalZoom. Retrieved from https://www.legalzoom.com/articles/joint-tenancy-vs-tenants-in-common
- Lander, S. (n.d.) Tenant-in-Common Investments. Zacks Investment Research. Retrieved from https://finance.zacks.com/tenantincommon-investments-8051.html
- Raitz, R. (2020.) IRS Provides Guidance on Using Tenancy-in-Common Interests in 1031 Exchanges. CCIM. Retrieved from https://www.ccim.com/cire-magazine/articles/irs-provides-guidance-using-tenancy-common-interests-1031-exchanges/