Converting An Apartment Building to TIC Without Evictions
It is possible to sell TIC shares one at a time as tenants vacate?
The practice of selling tenants in common shares over time is not only possible, it has become very common in recent years. This approach allows an owner to get the maximum sale price for his/her building without evicting any tenants. It also enables an owner to keep a stake in the building while simultaneously diminishing carrying costs and management responsibilities, and positioning the building for condominium conversion. The downside is that the owner has to be willing to share control with others and to rely on their financial strength. But many owners are realizing that they already share control of the building with their tenants and rely on their tenants’ incomes. Unlike co-owners, these tenants have no investment in the building and everything to gain from fighting with the owner. The reality may be that while having co-owners is risky, having San Francisco tenants is much, much riskier.
Owners can protect themselves from the financial risks of having tenancy in common co-owners
A popular was for apartment building owners to shield themselves from the financial risks of co-ownership is to carry all-inclusive “wraparound” financing for each TIC buyer. With this arrangement, the original owner continues to make all of the payments on any bank loan secured by the entire building, and the tenant in common co-owners make payments to the original owner. If a TIC co-owner does not make his/her payment, the original owner can foreclose using standard non-judicial foreclosure procedures (no court involvement). Non-judicial foreclosure is generally less risky than evicting a tenant in a rent-controlled city. Moreover, homeowner non-payments are extremely rare when compared with tenant non-payments, probably because a non-paying owner has a huge amount to lose.
The newly available individual TIC loans provide an even lower-risk financing option. With this arrangement, each TIC buyer gets his/her own bank loan. But this approach requires that the original owner sell enough TIC shares to repay his/her entire original loan. In other words, in order for their to be individual tenant in common loans, any apartment loan that was secured by the entire building would need to be paid off.
There are also well-tested methods of protecting the original owner from the risks of sharing obligations for property taxes, insurance premiums, and common area maintenance. The best approach is to create a monthly impound and reserve system so that payments for these items are made well in advance of when funds are needed. That way, any non-payment problems can be discovered and corrected through foreclosure or other legal remedies well before the bills are due.
Selling TIC shares will not increase property taxes
Selling tenancy in common shares will increase the property tax levied against the building, but will decrease the property taxes you pay. The Assessor reassesses the percentage sold at its sale price, but does not reassess the unsold percentage. So, if the assessed value of your building before the TIC sale is $500,000, and you sell a 25% interest in the building for $750,000, the new assessed value of the building will be $1,125,000 (75% of $500,000 plus $750,000). Properly drafted TIC agreements always provide that each owner pays property tax based on the assessed value of his/her percentage interest. So, in our example, the buyer would pay tax based on his/her purchase price of $750,000, and you would pay based on the $375,000 assessed value of the unsold 75%. Your property tax would drop by 25%.
Using proceeds of a TIC share sale in a 1031 tax-deferred exchange
Each TIC share sale can be treated as a separate transaction for the purpose of calculating capital gains tax, and the proceeds from each can be placed in a 1031 tax-deferred exchange. Alternatively, several TIC shares sales can be grouped together for exchange purposes provided they occur at the same time or within a relatively short period. But if you provide seller financing for the sale, the amount of this financing will be considered taxable boot unless you take precautionary measures. If such measures would be impractical under your financial circumstances, you can often achieve a favorable tax result by using installment sale tax treatment. Another alternative to a 1031 tax-deferred exchange might be a private annuity trust or “PAT”. Consult you tax or financial advisor for further information on these issues.
About the Author
SirkinLaw APC was a pioneer in the area of tenants in common (TIC) arrangements involving occupancy rights assignments, which are often used as a substitute for subdividing a property when true subdivision is impossible or unduly expensive. In 1985, Andy Sirkin created the legal and transactional structure which has become the industry standard for this type of TIC. Over the succeeding years, Andy’s innovations have included being the first state-approved real estate instructor for occupancy-based TICs, being the first to obtain state approval for a large-building TIC sale, being the first to convince institutional lenders to offer individual TIC financing, and being the first to develop the loan documents and lender underwriting guidelines for fractional TIC financing. In recent years, the type of co-ownership arrangement Andy conceived nearly 25 years ago has grown to comprise approximately 1/3 of all attached-home sales in San Francisco.
SirkinLaw APC has prepared close to 3,000 occupancy-based TIC agreements for properties of every size and type, and continues to assist in the vast majority of these transactions in California. This unmatched level of experience allows us to offer time-tested approaches for the vast majority of co-ownership situations, to quickly and effectively solve problems, and to produce documents that are clear, easy to navigate and read, and efficient and cost-effective to enforce. We continue to improve our documents each month as we encounter new situations and learn more about what TIC arrangements perform best in the real world. We also share our accumulated knowledge, and support real estate professionals and the TIC community, by continuously publishing new articles on our website and offering free educational workshops.
Our tenancy in common practice involves general advice and counseling, TIC agreement preparation, loan documents, and ongoing consultation to developers, seller, Realtors and TIC owners, on either a flat fee or hourly basis. We have a well-deserved reputation for returning calls promptly and providing fast turnaround times. But more important, we are known for finding creative solutions, calming fears, and finding common ground, so that transactions and relationships work. Although our role usually begins at the time the tenancy in common is first formed or sold, we are committed to remaining available to solve problems throughout the life of each TIC. Contact us via our contact form.