Starting and Operating A TIC Homeowners Association
Is a tenancy in common group a homeowners association?
This article provides step-by-step instructions for starting and running a tenancy in common (TIC) group where each of the tenants in common has the right to occupy a particular apartment, house, office or other area. It addresses the following frequently asked questions from the perspective of California law:
- Is a tenancy in common group a homeowners association?
- Should a tenant in common group create a corporation or other entity?
- When and how must the TIC group register and file forms with governmental agencies?
- What tax returns should a tenancy in common group file and what taxes must it pay?
- When should a TIC have its first owner meeting, and what should it do during that meeting?
- How does a TIC call and conduct an owner meeting?
- How does a TIC board of directors call and conduct a board meeting?
- How should a TIC create its budget and collect owner dues and assessments
- What records should a tenancy in common group keep and what reports should it make to its members?
- How can a TIC fine and discipline owners and otherwise enforce its rules?
Is a tenancy in common group a homeowners association?
This question is tricky because the term “association” has more than one meaning. It can mean a relationship between two or more people that are involved in some sort of joint undertaking, or it can mean an entity that has a legal existence separate from its members. Holding title to a property as a TIC automatically creates an association in the first, more informal, sense, because the tenant in common owners must associate to manage the shared elements of the property. But TIC owners do not necessarily need to have an association in the second, more formal, sense of a corporation or some other entity with its own distinct legal existence.
Should a tenant in common group create a corporation or other entity?
For a group to be a tenancy in common, it is necessary title to the property to be held in the names of the owners, rather than in the name of a limited liability company (LLC), corporation, partnership or trust. If the property is owned by an entity, and the owners of the entity have occupancy rights to specific apartments or other spaces, the group becomes a stock cooperative (or Co-Op) rather than a TIC, and is subject to different regulations and requirements. But the fact that the property must be held in the names of the owners does not mean that the TIC cannot form a corporation or other entity to act as its owners association.
In fact, the TIC should form a separate entity to act as its homeowners association if the benefits of doing so outweigh the costs and burdens. The primary benefits of forming such an entity are (i) making it easier for the TIC group to enter into agreements with services providers such as utilities and contractors, and (ii) protecting the tenant in common owners from personal liability arising from contracts entered into by the association. (Note that forming a corporation or other entity does not protect the owners from non-contractual liabilities such as injuries that occur on the property because, as noted above, title to the property will always be held by the owners rather than the entity.) These potential benefits must be weighed against the costs and burdens of creating and maintaining the entity, such as attorney fees, filing fees, annual tax preparation (federal and state), annual franchise tax ($800, unless tax exemption is obtained as discussed below), and the additional recordkeeping and decision-making formalities required by law for legal entities. In general, form a separate entity to act as homeowners association makes sense for a tenant in common group of 15 or more because a large TIC requires more services and the contractual obligations the group incurs are greater.
When and how must the TIC group register and file forms with governmental agencies?
Unless they choose to form a separate entity as discussed above, tenant in common groups are not required register or file forms with any governmental agency. Unlike condominiums, TICs are not required to make an annual or bi-annual filing with the Secretary of State. However, there are several optional filings that TIC groups may choose to do:
Obtaining An Employer Identification Number: An Employer Identification Number, or EIN, is a number that identifies the TIC group for tax purposes. To get an Employer Identification Number, a TIC owner or manager simply asks the internal revenue service to issue one. The request can be made online, in which case the number is issued instantaneously. Tenants in common groups are not required to have an EIN, so the TIC must weigh the benefits of getting one against the burdens of having one. On one hand, the EIN will make it possible to open a bank account without using the social security number of the owner or manager. On the other hand, it may force the TIC to file tax exemption requests and tax returns that it would not otherwise need to file (see discussion below).
Establishing Authority: A TIC group’s lack of independent legal identity can make it unclear who is authorized to act on the TIC group’s behalf, and this lack of clear authority can sometimes discourage vendors and other service providers from working with the group. One way to address this problem is by forming a corporation or other entity to act as a homeowners association but, as noted above, this imposes additional costs and burdens on the TIC. Alternatively, the tenants in common may file Articles of Organization with the Secretary of State or a statement specifying who has authority to accept legal papers on its behalf. California also allows a TIC group to record a Statement of Authority with the local County Recorder stating who has the authority to sign checks and contracts on its behalf. All of these filings are optional, and most TIC groups find them to be unnecessary.
What tax returns should a tenancy in common group file and what taxes must it pay?
Owning property as a tenancy in common does not, by itself, create an organization with an independent taxpayer identity, and the TIC has no obligation to file a return or pay taxes unless it has formed a corporation or other separate entity to act as its homeowners association. But the manner in which an unincorporated TIC group conducts its business can make it seem like a formal organization to federal or state tax authorities, and this appearance can trigger a demand by these authorities for a tax return. For example, when an unincorporated TIC gets an Employer Identification Number, it generally receives a letter requesting that it file a tax return. Most TIC groups in this situation get the request withdrawn by writing a responsive letter explaining the nature of the group and how it operates, but this provides only a temporary reprieve; the TIC will often receive another tax return request every year.
An alternative to the letter writing approach is for the unincorporated TIC group to formally establish its tax-exempt status. To obtain tax-exempt status at the federal level, the TIC files a Form 1120H with the IRS by March 15 of each year. To obtain tax-exempt status at the state level in California, the TIC files a Form 3500 with the Franchise Tax Board 90 days before the end of the first year the TIC exists (although FTB can issue the exemption retroactively). Unlike the 1120H, the 3500 is a one-time filing and need not be repeated each year. However, if the TIC collects more than $100 in income from sources other than owner dues and assessments in any particular tax year, it must file a Form 100 with the FTB (due March 15), and if its average annual owner dues collection exceeds $25,000 it must file a Form 199 with the FTB by May 15 each year. Note than a TIC that creates a corporation or other entity to act as its homeowners association is required to make each of these filings.
When should a TIC have its first owner meeting, and what should it do during that meeting?
A tenants in common group should have its first owner meeting as soon as possible after forming, and should discuss the following issues:
Item 1: Electing A Governing Board
Larger TIC groups generally have an elected board of directors authorized to make most (but not all) decisions. Having a board allows a larger TIC to operate more efficiently by avoiding the need to convene a meeting of all owners each time a decision is required. The number of directors, qualification of candidates, nomination system, and election procedures, will be described in the tenant in common agreement. Some TIC agreements provide for election of directors by cumulative voting. This means that each owner is allowed to cast a number of votes equal to the number of directors to be elected, and may choose to cast more than one of such votes for a particular candidate. For example, if three directors are being elected, an owner could choose to cast all three of his/her votes for one person. Cumulative voting is intended to give a dissenting minority of owners the power to elect a director to represent their viewpoint on the board.
Item 2: Electing an Officer or Officers
All TIC groups should have at least one member who is authorized to sign contracts and checks and otherwise act on behalf of the TIC. Larger TICs typically have several officers, including:
- A president, who presides at owner meetings and acts as the primary representative of the TIC;
- A secretary, who keeps meeting minutes and association records; and
- A treasurer, who creates or supervises budgeting, accounting and financial reporting.
In a TIC with a board, the board typically elects the officers. But when there is no board, the owners elect the officer or officers directly. The number and duties of officers, qualification of candidates, nomination system, and election procedures, will be described in the TIC agreement.
Item 3: Planning Management
Every TIC, including one consisting of only two owners or units, should have a plan under which a specific person is responsible for ensuring that the basic duties of the TIC group are fulfilled. These duties are:
- Creating the annual budget including a repair/replacement reserve contribution;
- Making sure that each owner has deposited his/her dues and assessments in the TIC account;
- Making sure the bills are paid;
- Keeping records;
- Making sure the common areas are cleaned and maintained; and
- Coordinating common area repairs
These tasks can be broken up and assigned to separate people. The responsible person for any particular task can be an owner or a paid manager. The tasks can be rotated. The key is that someone specific is responsible for each task, knows exactly what he/she is expected to do, faces consequences if the job is not done. What does not work over the long term is “we’ll just all pitch in” management.
Item 4: Developing A Tax Strategy
The tenant in common owners should decide whether or not to obtain an EIN and whether or not to formally establish tax exempt status.
Item 5: Opening Bank Accounts
TIC groups should have at least two bank accounts: one for its operating expenses (such as mortgage payments (unless the TIC is financed with individual, fractional financing), property tax, insurance, shared utilities, and management costs), and a separate one for its repair/replacement reserves. Most tenancy in common agreements require that repair/replacement reserve funds be kept in a separate account, and it is wise practice to do so even if it is not required. If either or both accounts do not exist at the time of the first meeting, an owner or manager should be assigned the task of opening them.
Item 6: Establishing an Operating Budget, Maintenance Reserves, and Assessments
Even a very small tenancy in common group should have an operating budget that includes both its current expenses and reserves for future repair and replacement costs. Most TIC agreements require a budget and repair/replacement reserves, and it is wise to do so even if there is no requirement. If no budget exists at the time of the meeting, or if the existing budget is out of date or prepared without a reasonable basis, an owner or manager should be assigned the task of creating a proper one. (For more details, see the discussion of budget preparation and owner dues below.)
Item 7: Confirming TIC Insurance
Tenant in common groups should routinely review the following aspects of their insurance policies:
- The expiration dates, to make sure they are in effect and timely renewed;
- The names of the insured party or parties, to make sure each owner is a named insured on each policy;
- The items covered on the casualty policy, to make sure that all parts of the building are covered either under the TIC policy or under the individual policies carried by the owners; the TIC group should specifically confirm that its casualty policy covers all of the elements that it is responsible to repair and replace;
- The limits of liability coverage to make sure they comply with the tenant in common agreement; and
- The limits of casualty coverage, particularly those relating to replacement costs and building code upgrades.
If any of these items cannot be verified at the meeting, an owner or manager should be assigned the task of verifying them.
Item 8: Creating a Schedule of Fines and Penalties
As discussed below, the most effective way for a TIC group to enforce its rules is to consistently impose penalties for rule violations. This approach requires that the tenants in common establish the penalties as soon as possible, before violations begin to occur. A perfect time to do this is at the TICs first meeting. Some important potential violations to consider penalizing are noise, improper parking, improper storage or placement of items in common areas, and failure to remove pet waste.
How does a TIC call and conduct an owner meeting?
The tenancy in common agreement should contain requirements for calling and conducting an owner meeting. In general, these procedural requirements will include:
- The number of days advance notice that must be given to each owner;
- The way the notice must be transmitted to each owner;
- Whether or not an agenda must be given with the notice;
- Whether matters not included in the agenda can be discussed or decided;
- The level of attendance required to conduct business (also called the “quorum” requirement);
- How owners not able to be physically present at the meeting can participate;
- The number or percentage of votes required to make various types of decisions;
- Whether and how decisions can be made without a formal meeting; and
- The extent to which records (or “minutes”) of the meeting must be kept, and how those records must be transmitted to the owners.
Ironically, small TIC groups generally have more difficulty than large ones with the meeting and decision-making process. One common source of difficulty is the failure to send each owner proper advance notice of each meeting with a full (and limited) agenda. Small tenancy in common groups generally assume this formality is unnecessary, with the result that meetings become difficult to organize and/or are poorly attended. More importantly, the lack of proper notice and agenda generally makes the decisions non-binding, meaning that any owner who disagrees can ignore or challenge them.
Another common problem for TICs is the failure to create particular, concrete proposals on which a yes/no vote can be taken, and to clearly record the resolutions passed at the meeting in a way that can be verified. Each discussion should eventually lead to a motion. Before a vote is taken, the motion should be written down, and passed around or read aloud. These rules may seem ridiculously formal for a group of two or three owners, but in fact they are extremely effective at making owner meetings more productive and minimizing the likelihood of disputes about what was decided.
How does a TIC board of directors call and conduct a board meeting?
For TICs with governing board, the tenant in common agreement will contain requirements for calling and conducting a board meeting, and these will typically cover the issues listed at the beginning of the preceding section. In general, even though owners not serving on the board cannot vote at board meetings, they are entitled to receive advance notice and an agenda, and are allowed a limited opportunity to speak. Keep in mind that any gathering (including a telephone call) where a majority of directors (which could be only two people where there is a three-person board) discuss TIC business that is subsequently voted upon by the board can be considered a meeting requiring advance notice and participation. Also remember to keep minutes of board meetings and to make them available to owners to the extent required by the TIC agreement.
How should a TIC create its budget and collect owner dues and assessments?
A TIC operating budget should consist of two components: the operating expenses, including recurring costs such as mortgage payments (unless the TIC is financed with individual, fractional financing), property tax, insurance, management, common area utilities, janitorial costs etc.; and the repair/replacement reserves, which is money collected in advance for eventual repair, refurbishment and replacement of the portions of the property that the TIC group is responsible to maintain. Ideally, both budget components should be based on facts about the specific property for which the budget is prepared rather than on industry statistics or generalized averages or, worse, “educated guessing”. The best practice for establishing the repair/replacement reserve component of the budget is:
- List all group-maintained components for which refurbishment or replacement will be needed in 30 years or less;
- List the estimated cost of refurbishment or replacement for each component;
- List the number of years before the item is expected to need refurbishment or replacement;
- Divide each component’s estimated refurbishment/replacement cost by the number of years, which will tell you how much to collect for the item each year; and
- Add the annual collection for each item to determine the total annual reserve collection.
Keep in mind that a small TIC (including a two-unit building) needs a properly prepared budget, including an accurate reserve calculation, even more than a large TIC, because a shortfall in TIC funds will have much more immediate and drastic effects when there are fewer owners to absorb it. It is risky to assume that either you or the other owner(s) will always have the funds available to make up a shortfall or respond to a funding emergency. Also remember that buyers and lenders will expect adequate reserves, and an owner who becomes accustomed to paying low dues will not be receptive to suddenly funding the missing reserves in order to help another owner sell or refinance.
The tenant in common agreement will generally describe the actions that an owner, or the group as a whole, is permitted to take when another owner does not pay dues or assessments. The most common remedy is a process under which the non-paying owner’s TIC interest is sold on the open market. The defaulting owner gets to keep any amount of the sale price left after paying costs of sale, mortgages, legal fees, and debts and penalties to the TIC group. This forced sale process is usually non-judicial, meaning that the TIC group does not need to go to court at any point during the sale process. Note that a forced sale is only useful if the value of the defaulting owner’s TIC interest is significantly greater than the amount he/she owes on a mortgage; otherwise, the proceeds from the forced sale, after payment of costs and mortgage, may not be sufficient to repay the owner’s debt to the TIC group. Also remember that the law prohibits any remedy under which the non-paying owner automatically looses his/her ownership share and investment.
Many tenancy in common agreements require a default reserve fund. This is money set aside for use by the group to pay bills if an owner does not pay his/her dues. Note that a default reserve fund is not the same as the repair/replacement reserve for building maintenance, and should be kept separate from other reserves so it is not accidentally spent to pay expenses.
What records should a tenancy in common group keep and what reports should it make to its members?
The tenancy in common agreement will describe the tenants’ in common record keeping and reporting requirements. In general, these requirements will include:
- Annual budget and repair/replacement calculation
- Bank records including reconciliations
- Tax returns
- Meeting notices and minutes
- Member list, including the names, addresses and contact information of each owner
- Insurance policies
- Agreements with service providers including any association manager
- Annually: Budget including repair/replacement calculation, and statement of dues
- Annually or more frequently: Report of income and expenses
- Annually: Summary of insurance coverage and/or copies of policies
- Annually: Schedule of fines and penalties
- Regularly: Meeting minutes
How can a TIC fine and discipline owners and otherwise enforce its rules?
Although a tenant in common group can bring legal action against an owner who violates its rules, this approach is often inefficient and ineffective. Legal action takes time, even when an alternative dispute resolution such as mediation or arbitration is used, and while the process is under way the rule violations tend to continue. Moreover, a court or arbitration order forcing an owner to do or not do something may not be obeyed, leading to further legal action (and frustration). A better approach is to impose monetary fines or penalties for rules violations. Fines and penalties deter violations by making the consequences seem more immediate and clear, and ease enforcement by converting the dispute from one about conduct to one about money. For this approach to work, the TIC group must adopt a schedule in advance, and send a copy to each owner each time a fine or penalty is established or adjusted.
FOR MORE INFORMATION
For more general information on tenancy in common groups where each of the tenants in common has the right to occupy a particular apartment, house, office or other area, please see my article entitled Tenancy in Common (TIC) Frequently Asked Questions.
For more information on strategies and remedies for nonpayment of owner dues and violations of TIC agreements, see my article entitled Enforcing Tenancy In Common Agreements and Resolving Tenant In Common Disputes.
About the Author
SirkinLaw APC is 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 some years, the type of co-ownership arrangement Andy conceived nearly 40 years ago has grown to comprise up to 25% of all attached-home sales in San Francisco.
SirkinLaw APC has prepared close to 5,000 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.