First American Exchange Company

A service from the Society’s 2006 Corporate Sponsor

TIC Summary

Kelly A. Pearl, CES®
Vice President – Branch Manager & Exchange Counsel
First American Exchange Company, LLC
2100 Fifth Avenue, San Diego, CA 92101
www.firstexchange.com | NYSE:FAF <http://www.firstam.com/investor>
Tel: 619.595.1263
Fax: 866.757.4994
Email: kpearl@firstam.com

Commercial property ownership provides real estate investors with the opportunity to complete like-kind exchanges under Internal Revenue Code section 1031. Investors can defer capital gains tax if they exchange investment property for property of a like-kind and invest pre-tax dollars into replacement investment property. In the real estate world, real property either held for use in a trade or business or for investment is like-kind to other real property held for use in a trade or business or for investment. However, investors are burdened with the headaches of the property search and selection, due diligence, leasing, property management responsibilities, etc. However, the TIC industry has come to the rescue, providing investors with fractional interest shares in pre-qualified investment properties tailored to the investor’s financial investment criteria.

When the ownership of real property is split in undivided fractional interests and held by two or more individuals or entities together, each owner is known as a tenant-in-common and each undivided fractional interest has come to be known as a TIC interest. In March, 2002, the IRS published Revenue Procedure 2002-22 in which it set forth conditions under which it would consider, if asked for a private letter ruling, the ownership of a TIC interest as the ownership of like-kind real property for IRC section 1031 purposes, as opposed to the ownership of an interest in a partnership or other entity, which would not qualify as like-kind to real property. The Rev. Proc. was issued as the result of a study by the IRS of undivided fractional interest programs which offer TIC interests as replacement property to taxpayers as 1031 exchange replacement property. The conditions the IRS desires to see in formalized TIC structures pertain to rights and obligations which are characteristic of, and inherent in, direct property ownership and include, but are not limited to: (1) no more than 35 co-owners may hold title to the property, (2) the co-owners must retain the right to approve certain actions such as hiring a manager, selling or leasing the property, creating blanket liens, etc., (3) any restrictions on a co-owner’s rights to partition, transfer or encumber their interest in the property can only be those required by a lender and consistent with customary commercial lending practices, (4) the co-owners may not conduct business activities with respect to the property other than providing customary services to tenants and (5) management agreements must be renewable no less frequently than annually.

This is not to say that qualification for the issuance of a positive private letter ruling under Rev. Proc. 2002-22, exempts a TIC program from federal securities laws. In March, 2005, the National Association of Securities Dealers (“NASD”) issued Notice 05-18 in which it stated that, in general, TICs constitute investment contracts and would, therefore, be securities for purposes of federal securities laws and rules including NASD Rule 2420 which prohibits the payment of commissions and fees to entities that operate as unregistered broker-dealers.

Since the publication of Rev. Proc. 2002-22, the commercial TIC industry has grown exponentially. The IRS expected to be flooded with requests for private letter rulings from TIC program sponsors and taxpayers. That has not been the case. To date, only four private letter ruling have been issued under Rev. Proc. 2002-22 and only two of which provided significant clarification of the IRS’s position on the structure of TIC programs.

On March 7, 2003, PLR 200327003 was issued and clarified the IRS’s position permitting (1) a ruling pertaining to generic form TIC program documents, with no specific property or investors referenced, (2) the sponsor to stay as a co-owner in the property for up to 18 months, and (3) non-affirmative consent to renewal of the management agreement.

On December 6, 2004, PLR 200513010 was issued in which the IRS approval of (1) a co-tenant’s right of partition being subject to a right of first refusal, at fair market value, of the other co-tenants, (2) the sponsor to remain indefinitely as a co-owner and (3) broader non-affirmative consent to renew of the management agreement. It also allowed the property management company to enter into leases without the unanimous consent of the co-owners, so long as the management company adheres to guidelines pre-approved, and is itself approved annually, by the co-owners.

Two additional private letter ruling, PLRs 200625009 and 200625010, were issued March 1, 2006, under Rev. Proc. 2002-22 and hold that in the context of two 50% co-owners, the buy-sell procedure in the facts was consistent with establishing a right to acquire 50% of the property at fair market value. The buy-sell procedure in these cases included a pre-offer notice from the initiating co-owner to the responding co-owner, coupled with due diligence disclosures, a 30-day good faith negotiation period between the co-owners, a subsequent formal offering notice for a stated price and a 90-day election period at the end of which, absent an affirmative election, the responding was deemed to have elected to sell his interest in accordance with the terms of the offering notice.

For additional information relating to TIC transactions or any other matter relating to §1031 Tax Deferred Exchanges, please feel free to contact Fran Buerman at 619-990-3374 (cell) or 888-835-3077 ext. 269 (office).

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