ARTICLES » NEWSLETTERS

TENANT IN COMMON INTERESTS

Fractional Ownership

In 2002 the Internal Revenue Service issued Revenue Procedure 2002-22 which contains guidelines relative to the acquisition of Tenant in Common Interests as qualifying replacement property in an Exchange. Specifically, the guidelines established certain requirements that needed to be met so that the acquisition of a Tenant in Common Interest would be treated as an interest in real estate and not a security. The result of the Revenue Procedure has been to spawn a new exchange related industry to provide an inventory of qualifying property interests for tax deferred exchanges under IRC §1031. Typically, a Tenant in Common sponsor, will locate and contract to acquire an institutional grade property which is divided into fractional interests and subsequently marketed to multiple investors. The types of properties and their locations are various. Typically the property will consist of class “A” apartment complexes, shopping malls, or office buildings and be leased to quality tenants. The fractional interests usually contain debt and equity components in the property in proportion to the percentage ownership to be acquired. The exchangor will acquire the Tenant in Common Interest using the proceeds from the sale of the exchangor’s relinquished property and by assuming a proportional amount of the debt. The properties are typically managed by professional management companies so that the exchanger does not have t be involved in the day-to-day operation of the property. Sales of tenant in Common Interests are handled through licensed broker dealers under the oversight of the Securities and Exchange Commission. Often, a broker dealer will represent several Tenant in Common sponsors each of which may have one or more available property offering. Typically, the broker dealer will have completed its own analysis and due diligence of the property offering and the sponsor and provide their findings to prospective exchangors. The benefits of acquiring an ownership interest in a Tenant in Common offering are as follows:

1. The exchangor desires to reduce management responsibility and hands-on involvement with the 
   property and tenants.    
2. The exchanger desires to acquire an interest in a multi million dollar class “A” property which he
   could not otherwise aquire.
3. The exchanger desires to diversify his/her holding by acquiring several Tenant in Common Interests
   offered by different sponsors in different locations.
4. The exchanger is unable to identify other suitable replacement property within the 45 day 
   identification period.

Some of the potential pitfalls of acquiring a Tenant in Common Interest are:

1. An investment in a Tenant in Common interest, is an investment in the sponsor. How long has the sponsor been in business? Does the sponsor have experience and a track record in structuring Tenant in Common deals? Has the sponsor successfully completed other Tenant in Common transactions?
2. Does the proposed transaction meet the guidelines established by Revenue Procedure 2002-22? Does the Tenant in Common interest qualify as replacement property in an IRC §1031 Exchange?
3. Do the Tenant in Common owners have the ability to hire and fire management? Does the management company have a successful track record?
4. A tenant can make or break any real estate deal. How strong are the tenants? How strong are the leases?
5. Every investment must end some day. Does the sponsor have an exit strategy?. Has the sponsor been successful in selling out similar investments at a profit. Does the exchangor have the right to sell individually? What if you need to get out prematurely? Is there a secondary market for your Tenant in Common Interest?

The specific requirements for a qualifying Tenant in Common Interest are as follows:

1. Each co-owner must own a fee interest in the property as a tenant in common under local law. The property as a whole can not be owned by an entity. The number of co-owners can not exceed 35.
2. The co-owners may not file a partnership or corporate return, conduct business under a common name, form a partnership or other business entity, or hold themselves out to be partners, shareholders, or members of a business entity.
3. The co-owners must have the right to approve the management company, the sale of the property, any leases, and any debt. All such decisions must be made by the unanimous approval of the co-owners.
4. Each co-owner must have the right to transfer, encumber and partition the co-owner’s tenant in common interest in the property without the agreement or approval of any other person.
5. Each co-owner must share in the revenues and costs associated with the property in proportion to the co-owner’s percentage tenant in common interest.
6. Each co-owner must share in any loan secured by the property in proportion to the co-owner’s percentage tenant in common interest.

Tenant in Common or fractional ownership is rapidly becoming a recognized tool in the exchange industry and the concept and practice of acquiring tenant in common interests as qualifying replacement property is growing at a remarkable pace in order to meet investor demand. More and more sponsors and broker dealers are appearing in the marketplace with numerous property offerings. While tenant in common ownership may not be ideal for all investors, many investors are sure to find the opportunities offered by the tenant in common industry both competitive with conventional real estate investments and rewarding.