When a TIC Group Wants Different Things: Partial Exits and Exchanges

A partial exit is a sale of undivided interests, not a sale of the building

The owners who stay keep the deed they already have. The leaver conveys its undivided interest, and Reg. section 1.1031(a)-3(a)(5) names co-ownership among the intangible interests that are real property for section 1031, so the leaver's exchange is an ordinary one. Reg. section 301.7701-1(a)(2) is the other half of the foundation: co-owners who merely maintain, repair and rent the property have not formed an entity, so each is its own taxpayer.

That is what makes mixed outcomes possible without a group sale. One co-owner takes cash and pays tax, another exchanges into a trust, a third exchanges into a building across town, and the two who stay do nothing on their returns except note a changed percentage. TIC group exchanges without unanimous consent covers the whole-property sale; this page is the case where the building is not sold.

The buyer can be a stayer increasing its share, or a newcomer. Either way the buyer signs the existing co-ownership agreement, and if the group follows the ruling guidelines in Rev. Proc. 2002-22, the count stays at 35 persons or fewer and nobody starts holding the group out as a partnership.

The lender decides whether the stayers can absorb the leaver's share of the loan

Section 6.09 of the revenue procedure has each co-owner share the blanket-lien debt in proportion to its interest, and section 6.06 allows the lender to restrict transfers in line with customary commercial practice. A partial exit therefore needs the lender's consent twice over: to release the leaver from its share and to let the stayers' shares rise.

For the leaver the debt is the tax problem. Under Reg. section 1.1031(d)-2 the share of the loan the buyer takes over is money received, so a leaver with a 25 percent interest in a building carrying a $1,200,000 loan has $300,000 of debt relief to replace with new debt or cash before any of the gain is deferred. That figure, not the cash price, decides whether the leaver needs a financed trust; whether a DST's loan counts as replacement debt explains how trust-level financing is credited.

The buyer's side has its own exchange question. A stayer buying out the leaver with cash from the sale of a different property can treat the undivided interest as replacement property for that exchange, which buying out a co-owner with 1031 proceeds covers, provided the related-party rules below do not get in the way.

Pricing the fraction and the related-party trap

Inside the group the revenue procedure gives a yardstick for price: section 6.10 allows a call option on a co-owner's interest only at the fair market value of the whole property multiplied by the co-owner's percentage, and section 6.06 permits a right of first offer in favour of the other co-owners, the sponsor or the lessee. A current appraisal of the building, applied pro rata, is the usual starting point.

Family groups must then read section 1031(f). If the leaver exchanges after selling to a related person, and either party disposes of the property it received within two years, the leaver's deferred gain is recognized in the year of that disposition. Related persons are defined through section 267(b), and section 267(c)(4) puts brothers and sisters, the spouse, ancestors and lineal descendants in the family. Exceptions cover a disposition after a death, an involuntary conversion, and transactions the IRS is satisfied were not designed to avoid tax.

The reporting follows. The Form 8824 instructions require the exchanging co-owner to file the form for the two years after a related-party exchange and to report the deferred gain if a disqualifying disposition occurs. A sibling buying a sibling's share should therefore plan to hold for two years, as selling to a family member in a 1031 explains.

If the group has been filing a Form 1065, a partial exit is a redemption, not a real-property sale

Some groups that call themselves TICs have filed partnership returns for years, kept a common name, or shared profits from services to tenants. Section 1031(a)(2) excludes interests in a partnership, and section 1031(e) rescues only a partnership with a valid section 761(a) election, which the revenue procedure's section 6.03 echoes by refusing to rule for a group that held the property through a partnership immediately before. For such a group, a departing member is redeemed out of a partnership, and there is no real property to exchange.

The fix is a drop before the swap: the partnership distributes undivided interests to its members, who then hold as tenants in common and sell or exchange individually. Timing is everything, because the IRS's published view denies exchange treatment when the distribution is one step in a prearranged sale, and the group's own Form 1065 asks whether such a distribution occurred. Drop-and-swap and swap-and-drop strategies sets out the authorities and the timing ladder.

Worked model: three co-owners, one leaving, siblings on both sides

Hypothetical, round numbers. A holds 50 percent and B and C hold 25 percent each of a building worth $3,000,000 with a $1,200,000 loan. B wants out; A and C want to keep it. B's share is worth $750,000, B's share of the loan is $300,000, and B's adjusted basis is $350,000.

A buys B's interest. A pays $450,000 of cash and, with the lender's consent, takes over B's $300,000 of the loan, so A now carries 75 percent of it. B's amount realized is $750,000 and B's gain is $400,000. To defer all of it B needs at least $750,000 of replacement property carrying at least $300,000 of debt: a trust financed at 40 percent loan-to-value absorbs the $450,000 of cash and brings $300,000 of its loan. A debt-free trust would leave $300,000 of boot taxable.

If A and B are siblings, section 1031(f) applies to B's exchange. A must hold the purchased interest for two years, or B's $400,000 of deferred gain comes back in the year A sells. Every figure here is invented to show the mechanics; have your CPA run the real ones before the price is agreed.

Where each leaver's share goes

Co-owners leaving a shared building rarely want another one. A DST gives each leaver a replacement sized to its own proceeds and debt, with a trustee holding the loan and no further votes, which Rev. Rul. 2004-86 treats as an undivided interest in real estate for section 1031. The interest is also an illiquid private placement: no public market, a sale date set by the sponsor, distributions that can fall or stop, and principal that can be lost, so a leaver who may need the cash within a few years should take some of it as boot instead.

Each leaver's 45-day and 180-day periods under Reg. section 1.1031(k)-1 run from the date its own interest transfers, so two leavers closing on different days have different deadlines. A leaver whose debt share is high relative to its cash is the candidate for a cash out DST; a leaver with no loan to replace fits an all-cash traditional DST. A partner, rather than a co-owner, who is the only one wanting cash is a different case, covered in when only one partner wants to cash out.