Pitfalls to Avoid in Group Ownership of 1031 Exchange Property

Two years ago the IRS issued guidelines for taxpayers who wish to buy a small slice of a large property. Their ruling covers groups that are put together by promoters, or "sponsors" and is intended to cover groups comprised of people who don't know each other. These groups are known as "Tenants-In-Common", or "T.I.C.s" and most often called "TICs" (rhymes with "sticks") in the real estate industry.

The ruling sets out the minimum requirements that must be met before the IRS will accept an application for a group's exemption from the partnership rules. Being subject to the IRS's partnership rules would be fatal for a TIC.

Since this ruling was released, the TIC industry has exploded and is easily the fastest growing segment of the real estate industry.

A quick search for "tenants in common" on Google as I write this article produced over 471,000 hits. Allowing for duplicates, etc., this means that there are a couple of hundred thousand web sites trying to market TIC properties. Pretty amazing when you learn that only one group has applied for approval of their transaction (or so the IRS tells us -- they have approved only one and claim they have denied none).

While these transactions can be very beneficial to some investors, we advise our clients to approach them very carefully. We continually observe cautious, conservative investors getting carried away by a slick marketing brochure.

Remember that the IRS guidelines are the minimum that are required to get a ruling.

We've seen some really awful programs, that don't even come close to meeting the minimums, being aggressively marketed as being blessed by the IRS since they meet most of the requirements, or "the major requirements" of the ruling.

We've seen some really greedy promoters pushing really bad properties through some very beautiful advertising pieces. Our advice to our clients is to approach these investments with great care: do your due diligence. Ask yourself this question "If this is such a great investment, why do they need me to invest in it?". Make sure that you know exactly what compensation the sponsor is going to receive by putting the deal together. There is nothing wrong with making a profit, but not by gouging trusting and unsophisticated people.