TIC Corner

Selling Buildings One TIC at a Time

by D. Andrew Sirkin

Q. Is it possible to sell TIC shares in my building one at a time as tenants vacate?

A. The practice of selling TIC shares over time is not only possible but has become very common in recent years. This approach allows an owner to get the maximum price for her building without evicting any tenants. It also enables an owner to keep a stake in the building while simultaneously diminishing carrying costs and management responsibilities, as well as positioning the building for condominium conversion. The downside is that the owner has to be willing to share control with others and to rely on their financial strengths. But many owners are now realizing that they already share control of the building with their tenants and rely on their tenants’ incomes. Unlike co-owners, these tenants have no investment in the building and everything to gain from fighting with the owner. The reality may be that while having co-owners is risky, having San Francisco tenants is much, much riskier.

Q. Can an owner effectively protect herself from the financial risks of having TIC co-owners?
A. A popular way for apartment-building owners to shield themselves from the financial risks of co-ownership is to carry all-inclusive “wraparound” financing for each TIC buyer. With this arrangement, the original owner continues to make all the payments on any bank loan secured by the entire building, and the TIC co-owners make payments to the original owner. If a TIC co-owner does not make her payment, the original owner can foreclose, using standard nonjudicial foreclosure procedures. (In other words, no court involvement is necessary.) Nonjudicial foreclosure is generally less risky than evicting a tenant in a rent-controlled city. Moreover, homeowner nonpayments are extremely rare when compared with tenant nonpayments, probably because a nonpaying owner has a huge amount to lose.

Newly available individual TIC loans provide an even lower-risk financing option. With this arrangement, each TIC buyer gets her own bank loan. But this approach requires that the original owner sell enough TIC shares to repay her entire original loan. Basically, in order to get individual TIC loans, any apartment loan that was secured by the entire building would need to be paid off.

There are also well-tested methods of protecting the original owner from the risks of sharing obligations for property taxes, insurance premiums and common-area maintenance. The best approach is to create a monthly impound-and-reserve system so that payments for these items are made well in advance of when funds are needed. That way, any nonpayment problems can be discovered and corrected through foreclosure or other legal remedies well before the bills are due.

Q. Would selling TIC shares increase my property taxes?

A. Selling TIC shares will increase the property tax levied against the building but will decrease the property taxes you pay. The assessor reassesses the percentage sold at its sale price but does not reassess the unsold percentage. So, if the assessed value of your building before the TIC sale is $500,000, and you sell a 25% interest in the building for $750,000, the new assessed value of the building will be $1,125,000 (75% of $500,000 plus $750,000). Properly drafted TIC agreements always provide that each owner pays property tax based on the assessed value of her percentage interest. So, in our example, the buyer would pay tax based on her purchase price of $750,000, and you would pay based on the $375,000 assessed value of the unsold 75%. In other words, your property tax would drop by 25%.

Q. Can I put the proceeds of a TIC-share sale in a 1031 tax-deferred exchange?

A. Each TIC-share sale can be treated as a separate transaction for the purpose of calculating capital-gains tax, and the proceeds from each can be placed in a 1031 tax-deferred exchange. Alternatively, several TIC-share sales can be grouped together for exchange purposes, provided that they occur at the same time or within a relatively short period. But if you provide seller financing for the sale, the amount of this financing will be considered taxable “boot” unless you take precautionary measures. If such measures would be impractical under your financial circumstances, you can often achieve a favorable tax result by using an installment-sale tax treatment. Another alternative to a 1031 tax-deferred exchange might be a private annuity trust. Consult your tax or financial advisor for further information on these issues.

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or the San Francisco Apartment Magazine. The information contained in this article is general in nature. Consult the advice of an attorney for any specific problem. D. Andrew Sirkin’s law practice is devoted exclusively to tenancy-in-common, vacation-home sharing, equity sharing, investment partnerships and other co-ownership matters. Copyright � 2006 by the San Francisco Apartment Magazine. All rights reserved.