What to Do with Troubled TICs? Considerations for Lenders: Lenders May Be Able to Reform Loan Documents and Enhance Their Position with Tenant-in-Common Borrowers in the Aftermath of the Economic Downturn
Caufield, Steven A., The RMA Journal
Between 2002 and 2008, the commercial real estate industry witnessed an explosion in the popularity of real estate investments in tenant-in-common (TIC) structures. The impetus for this remarkable increase in popularity was an IRS revenue procedure issued in 2002.
The procedure gave comfort to investors and financial advisors that capital gains earned from selling real estate could be reinvested into TIC interests in revenue-producing properties, with no recognition of capital gains under the like-kind exchange rules of Internal Revenue Code Section 1031. Investors pooled assets with others to invest in TICs, owning everything from apartment buildings to office towers. The rapid growth of the industry, riding on the front edge of the real estate bubble, was fueled by TIC sponsors and syndicators who offered investors their services to identify co-investors and provide documentation to create and manage the TIC structure. In many situations, they offered a guaranteed return on the investment.
The relative dearth of practical, judicial, or legislative guidance on TICs as a modern real estate investment tool led to a wide array of TIC structures, governed by widely varying documentation. Equally uncertain was how lenders should protect themselves against various issues specific to the structure.
Over the last several years, commentators have suggested various structures and provisions that TIC lenders should include in their TIC loan documentation to provide the optimum level of protection. However, given the lack of established practices for TICs and the rapid expansion of the industry, it is likely that many lenders currently do not enjoy the benefit of these protective measures. Further, many loans to TICs were negotiated and managed through sponsors. As these sponsors failed during the economic downturn, many lenders and investors were left with unanswered questions and serious issues with their TIC properties.
As defaults occur and loan maturities approach, lenders may now have an opportunity to reform loan documents and TIC structures to help good TIC assets become better loans, enhancing the functionality of the borrower and the security of the lender.
This article provides a brief background on the development of modern TICs, along with a discussion of some important points for lenders who have outstanding loans on TIC assets syndicated and managed by failed or bankrupt sponsors. Also offered are some general considerations for lenders who may have the opportunity to reform TIC loan documents or master leases.
IRS Revenue Procedure 2002-22
The tenancy-in-common structure has been around for centuries and, until recently, had not deviated far from its common-law ancestry. In a traditional tenancy in common, each co-tenant owns an undivided interest in the property. The law of the jurisdiction controls certain aspects of their relationship, such as when an individual co-tenant can seek a partition of his or her interest, when co-tenants may seek to oust a fellow tenant, and how the co-tenancy interest passes in marriage, divorce, and death.
Similarly, for decades, the IRS has offered taxpayers the ability to defer capital gains through like-kind exchanges. However, investors seeking to reinvest capital gains from the sale of real estate through an IRC Section 1031 exchange generally would not invest those gains through a TIC structure. The reason was uncertainty over whether the structure would be recognized by the IRS as an investment in real estate or as an investment partnership, the latter failing to achieve nonrecognition of gains.
In 2002, the IRS addressed this issue with IRS Revenue Procedure 2002-22. The procedure sets forth 15 conditions under which the IRS will consider a request for a ruling that an undivided fractional interest in real estate (a TIC interest) will be recognized as such in a like-kind exchange, and not as an investment in a business partnership. …