Preface: Tenants-in-common. What’s with the signature?
Tenants-in-Common Real Estate
As with any real estate decision, the right advice before committing your cash can be the difference between a gain, or loss, on sale. In tenant in common real estate holdings, this is particularly true. Before you sign on a tenant-in-common purchase of real estate, consult with your attorney or CPA. It’s important to think through the structuring of the deal and your risks with an expert. Here are a few items to prepare you for that conversation.
A tenant in common ownership is an undivided interest in property. The deed shows only the ownership percentages. A few disadvantages of tenants in common ownership: say one owner decides they will not pay their share of property expenses for the year, the other tenants in common are required to pay up and cover that gap. If a majority owner becomes disgruntled, you could be required to pay additional expenses on tenant in common property. At any time a tenant in common can sell their share of property without consent of the other owners. This could lead to you sharing your investment with someone you don’t know. Each tenant in common owner is responsible for their share of the property including mortgage(s), taxes, insurance, and maintenance costs. If the tenant in common investment is yourself and a friend, the structure is not complicated. Yet, the more investors involved in your tenant in common investment, the more chance for a financial hurricane.
Plan your exit strategy beforehand. Think how you would like to exit your interest should want to redeploy your cash. You need to understand how you can, or will, sell your ownership position in the future. If you’re buying with friends, how liquid is your interest? What if you decide you want your equity for another investment opportunity; how easy will it be to cash out? Having an exit plan cannot be overemphasized. The right professional advice is often key to avoiding future hassles. Tenants in common can work great with the right group; but it’s prudent to plan ahead.
Tenant in common agreements are a written contract signed by all co-owners detailing who can use the property. This outlines who and how the property will be managed. Tenants in common are limited to 35 participants according to IRS regulations. Tenants in common own individual shares of property and need not be equal. However, all owners have the right to use, or live in the property. So for instance say 5 friends decide to buy a stable to facilitate their shared equestrian hobby. They will all have equal rights to the property; but cohesiveness is required to maintain a good working tenant in common interest. Now say the 5 decide to acquire the stable to run as a business. They are now a partnership for tax purposes. The definition of tenant in common and partnership is opaque. But according to Rev. Ruling 75-374 a two person co-ownership of an apartment building rented to tenants is not a partnership for federal tax purposes. Simply, tenant in common ownership must not include any type of business activity.
Summary: Tenant in common ownership of real estate works in specific instances, i.e. common occupation of real estate. If you are considering a tenant in common interest, it’s likely >+1 significant dollars. Talk with a CPA or attorney to make an informed financial decision.