Publications

Phillip C. Querin
Partner - Portland, Oregon Office

philquerin@dwt.com
(503) 241-2300

Realtors® and Tenancy in Common Interests
[January 2006]

Over the last few years there has been a boom in the sale of tenancy in common interests, or “TICs.” It has reached such a pitch, that one article recently referred to the phenomenon as “TIC Fever.”¹ There is nothing new about TIC interests. In their simplest form, they are merely a fractional real property ownership interest involving two or more persons.²

Historically, TICs usually occurred between a small group of people, frequently related or known to each other. Co-ownership of a vacation home would be a common example. However, in 2002, the Internal Revenue Service issued a ruling that permitted TIC interests to be used in Section 1031 exchanges. Section 1031 is that portion of the tax code that permits owners of business, income or investment property to defer their taxable gain by exchanging it with a replacement property rather than selling it outright for cash. The law is complicated and requires that certain deadlines be met in order to qualify. Two of those deadlines state that the seller has 45 days from closing to identify not more than three replacement properties³ and 180 days to close on at least one of them. Failure to meet a deadline will result in the owner having to recognize the gain in the year of sale and pay taxes on it, rather than indefinitely deferring it as permitted under Section 1031. However, finding replacement property can be difficult and time consuming.

The IRS ruling that permitted people to exchange into and out of TICs made this form of fractional ownership of real property an attractive investment vehicle. It allowed investors to own a small piece of high grade real estate, which was oftentimes easier to sell than trying to dispose of an entire parcel of property. With the flattening of the stock market over the last several years, real estate, including TIC interests, have become a sought-after form of investment.

The result is that TIC interests are now being packaged and sold by “sponsors” to investors. Since these interests deal with real estate, Realtors® have become involved in marketing them, and this is where there is risk. If the sale of a TIC interest is regarded as a real estate transaction, as the IRS treats them, then Realtor® involvement is permissible; if it is viewed as a security, which is how the Security and Exchange Commission treats them, then Realtor® involvement would be illegal without a securities license. A National Association of REALTORS® work group has concluded that there is “no clear guidance” on the issue of whether Realtors® need to be licensed as securities dealers when they are involved in the sale or marketing of TIC interests. The Oregon Real Estate Agency’s October 2005 OREN-J republished an article by the Oregon Division of Finance and Corporate Services, warning real estate agents about accepting commissions from the sale of TIC interests unless the agent is also licensed as a securities dealer. Currently, there are no legally recognized “safe harbors” that dictate precisely when Realtors® may promote or sell TIC interests without a securities license. Here are some rules of thumb for Realtors®:

• Most TIC interests are packaged and marketed as securities. Because of the costs associated with complying with securities laws, the fees, costs and commissions are “front-end loaded” into their acquisition price. There are also costs of centralized management, operation, and ultimate sale of the TIC. Such costs must be carefully evaluated when analyzing a TIC interest for an investor.
  
  
• A TIC interest marketed as a security will usually be accompanied with a private placement memorandum (“PPM”) required by the SEC, outlining the investment risks. However, the absence of a PPM does not necessarily mean that the TIC interest is not a security.
  
  
• A security usually involves unrelated passive investors who have delegated control of the entity to others through a centralized form of management.
  
  
• If the TIC interest is a security, sale without a securities license can be a violation of state and federal laws, and result in civil and criminal penalties.
  
  
• If the TIC investment is unsuccessful, disgruntled investors may claim that under the securities laws they can hold the Realtor® who sold it to them, liable.
  
  
• Most Realtor® E&O policies will not cover securities claims against agents.
  
  
• It is against the law for a securities dealer to compensate a real estate licensee for their involvement in marketing a TIC interest – this would apply whether the compensation is a commission or a referral fee.
  
  
• Brokerages should consider adopting company policies and education on the issue.
  
  
• Companies should consider increasing principal broker oversight when TICs are marketed by their agents.
  
  
• The sale of real property to a securitized TIC is not a violation of the securities law – it is the sale of a securitized TIC interest to investors that could be illegal if done without a securities license.

FOOTNOTES

1 The Real Estate Center – Texas A&M, July 2005. See, http://recenter.tamu.edu/tgrande/vol12-3/1735.html.

2 Two variants of tenancy in common interests are joint tenancies (not technically recognized in Oregon) and tenancy by entireties. The former includes a right of survivorship upon death of a joint tenant and the latter, which also carries a right of survivorship, is between a husband and wife.

3 There are some exceptions to the 3-property rule, though not germane here.

© Copyright 2006. Phillip C. Querin, Davis Wright Tremaine. No part may be reproduced without the author’s express written consent.