Supreme Court Hints at TIC Referral-Fee Rules for Real Estate Brokers

Two years ago, the IRS issued Revenue Procedure 2002-22 which blessed Tenant-In-Common, or "TIC" (rhymes with "pick") properties as qualifying for Section 1031 as replacement properties. In the last two years I've watched that industry explode. For example, a recent search on Google under "Tenants in Common" returned about 490,000 hits -- most of them sellers or "sponsors" of TIC properties. Many of our client's real estate brokers are uncertain as to what the ramifications are if they accept a commission or referral fee from a sponsor to whom they refer clients. A recent Supreme Court case would seem to answer this question -- and it isn't pretty!

For clarification, if you and a couple of your friends buy a property, you might legally hold title to the property as "tenants-in-common." Because you are friends and know each other you are not subject to the TIC rules. But if you hire a sponsor to help you find other investors for your project, you've crossed a line and are subject to the Rev. Proc. TIC rules.

The issue is whether a referring real estate broker can accept a commission from the sponsor, (since the property owned by the TIC is real estate), or whether the TIC investment represents a security requiring a NASD Series 7 securities license. One of the largest TIC sponsors estimates that perhaps 70% of their referrals come from securities brokers and 30% come from real estate brokers. So, can you, as a real estate broker, accept a TIC commission for a referral?

In a recent US Supreme Court case, SEC v. Edwards, the court seemed to indicate that you need a securities license. The case actually involved a payphone scheme, but the court's opinion gives us good insight on how the court might react if they were to decide a similar TIC case.

...the Supreme Court's opinion gives us insight on how they might react to a TIC case.

The court held that "...an investment scheme promising a fixed rate of return can be an 'investment contract' and thus a 'security' subject to federal security laws." Its logic was that "congress' purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called," and that the definition of a "security" is broad enough to include investment contracts. In other words, if the court believes that the TIC agreement is an "investment contract" (which seems logical to me that it would be), then the TIC investment would be a security as opposed to a real estate contract. I'm not stating this as fact, but simply that I can see the court coming to this conclusion.

One of the apparently fatal problems in the Edwards case was the fact that Edwards promised (guaranteed) a fixed rate of return on the investment. Many of the TIC deals that we see involve promises of a fixed return or cash flow, with the future appreciation of the property as the kicker. The problem with guarantees of a fixed rate of return is that they are designed to attract investors into the project. In other words, the offer of guaranteed investment income makes it an investment contract, which makes it a security. That's how the Federal Government might come down on this; there is currently no information about how the State views realtors accepting a referral fee or commissions from TIC sponsors.

So what should this mean to you? If you are a real estate broker, I suggest you think twice before accepting a commission or referral fee from a TIC sponsor unless you have a Series 7 securities license. And it probably wouldn't be a bad idea to talk to your attorney and make sure you have his approval before you accept the fee.