Tenants-in-common 1031 exchange

A tenants-in-common 1031 exchange is a form of real property co-ownership structure used in the United States in which two or more persons each hold an undivided fractional interest in the same property, with ownership shares that need not be equal and that may generally be sold, transferred, or inherited separately. Each co-owner receives an individual deed for their undivided percentage interest in the entire property and is typically entitled to a proportionate share of income, appreciation, and tax benefits, subject to any co-ownership agreement and applicable law.^[1][2]

In a TIC 1031 exchange, a taxpayer completes a like-kind exchange under Internal Revenue Code section 1031 by acquiring an undivided tenants-in-common (TIC) interest in replacement real property, instead of 100 percent ownership of a single parcel.^[3][4] TIC structures became more prominent in the early 2000s after the Internal Revenue Service issued Revenue Procedure 2002-22, which set out guidelines for ruling requests on whether TIC interests would be respected as real property rather than partnership interests for purposes of section 1031.^[1][2]

Since amendments enacted by the Tax Cuts and Jobs Act took effect in 2018, section 1031 like-kind exchange treatment has generally been limited to exchanges of real property; however, TIC interests in qualifying real estate may still be used as replacement property in appropriate circumstances.^[3][5]

Regulatory guidance

In Revenue Procedure 2002-22, the Internal Revenue Service provided a set of conditions under which it would consider issuing favorable private letter rulings for co-ownership arrangements structured as tenants in common interests used in section 1031 exchanges.^[1] The guidance outlines a number of factors that are intended to distinguish TIC arrangements that are treated as direct ownership of real property from arrangements that may instead be characterized as interests in a business entity, which would not qualify for nonrecognition treatment under section 1031.^[2]

Although Revenue Procedure 2002-22 does not create a formal "safe harbor", the factors it lists have been widely used in practice by sponsors and advisers in structuring TIC offerings that are intended to qualify as like-kind replacement property.^[2]

Securities regulation

Because TIC 1031 interests are often offered to multiple investors through broker-dealers, U.S. securities regulators have taken the position that many TIC interests offered in connection with section 1031 exchanges are securities, and that firms recommending them must comply with applicable suitability, supervision and advertising rules.^[6][7] Academic commentary has examined the intersection of section 1031, TIC structures and the federal securities laws, highlighting both the tax-planning opportunities and the complexity and risks involved in such offerings.^[8][9]

How a 1031 exchange is accomplished

A like-kind exchange under Internal Revenue Code section 1031 typically follows a set sequence of steps, including engaging a qualified intermediary, selling the relinquished property, and then identifying and closing on replacement property within statutory deadlines of 45 days to identify replacement property and 180 days to complete the exchange.^[3][4] The following sequence represents the order of steps in a typical 1031 exchange.

1. An investor decides to sell investment property and do a 1031 exchange. He contacts a qualified intermediary (QI) and they enter into an agreement.
2. The investment property is placed on the market.
3. An offer to purchase the investment property is accepted and signed by the QI.
4. Escrow for the sale is opened, and a preliminary title report is produced.
5. The QI sends required exchange documents to the escrow closer for signing at property closing.
6. Escrow closes.
7. Within the first 45 days after the close of escrow on the sale of the relinquished property, the investor identifies replacement properties as required by law. This is known as the "Identification Period".
8. Within 180 days after the close of escrow on the sale of the relinquished property, the investor closes on one of the replacement properties which he has identified. This is called the "Exchange Period". This completes the exchange. No cash – or boot, as it is known – is taken by the exchanger.

An alternative to the 1031 exchange

A structured sale annuity, sometimes marketed as an "Ensured Installment Sale", is a capital gains tax deferral technique in which the seller receives installment payments funded through an assignment company and annuity, rather than a lump sum.^[10] It has been described as a hybrid of the common installment sale and a structured annuity and can allow the seller to collect a stream of payments and manage the timing of income for tax purposes.^[10] In practice, a structured sale may be used by taxpayers who are unable or unwilling to complete a section 1031 exchange within the required time frames, and who prefer an installment arrangement while still disposing of the underlying property.^[10]

See also

• 1031 exchange
• Revenue Procedure 2002-22