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Shopping Centers Today -> February 2003
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TIC DEALS FLOURISH IN WAKE OF NEW IRS RULES
If the stock market uncertainty of the past two years has given investors an incentive to invest in real estate, the Internal Revenue Service’s issuance of clear guidelines on tenancy-in-common, or TIC, agreements provides another.
This comes just as TICs, a by-product of the 1031 exchange market, are increasingly drawing investor attention — and dollars.
Though the TIC market is hard to gauge (the IRS keeps close records, but does not publicize the information and is equally unforthcoming about 1031 exchanges), TICs account for about $1 billion of the $200 billion to $300 billion of 1031 exchange deals done each year, according to Rob Hannah, CEO of Tax Strategies Group, a Chicago real estate investment firm.
About 40 companies now offer TIC services, up from only three such companies seven years ago. Sometimes called exchange accommodators or intermediaries, these firms acquire properties and then sell portions to investors who want to buy tenancy-in-common interests.
“This is clearly the new wave of investment — for 1031 exchanges and real estate at large,” said Hannah.
A 1031 exchange allows an owner to sell one property and buy another of equal or greater value within 45 days without incurring capital gains taxes. Some sellers, however, find that 45 days is not enough time to locate a property suitable for a 1031 exchange. But with a TIC, the seller can, if unable to purchase a property outright, buy a fractional interest for a 1031 exchange instead.
Last March the market got a significant boost when the IRS drafted Revenue Procedure 2002-22, a set of 15 guidelines by which the industry could set up legal TIC structures for 1031 exchanges. Before that, many investors and property owners had complained that the rules were unclear.
“As long as you are in the boundaries of those 15 points, you can create any structure you want,” said Hannah. “It’s given the market guidance, and is contributing to the popularity of 1031 exchanges.”
A guideline that allows TIC participants to sell their portions to a property’s other interest holders does not oblige the latter to buy. The IRS meant to encourage participants to treat TIC interests as investments rather than as assets for active trading, Hannah said.
Although TICs were originally used to facilitate 1031 exchanges, the guidelines have stimulated interest from individuals seeking reliable investment options.
Many TIC deals involve neighborhood and community centers, as well as big-box properties occupied by retailers with excellent credit, said Richard Lipton, a Chicago-based tax attorney.
For strip center TICs, the property owner can create what is called a master lease to reduce the risk to each individual investor or bring in a property manager. In a master lease, the co-owners lease the property to a third party, who in turn subleases to individual tenants.
The beauty of such an arrangement is that it takes on the characteristics of a triple-net lease, in which the owner takes a very passive role in the day-to-day operations and financial responsibilities of the property. Given the declines in the stock and bond markets, Hannah observes, people are looking to real estate as the investment vehicle of choice. TIC arrangements meet the needs of investors to invest passively — as they have done before with equities or fixed-income, he said.
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