What investors need to know about ICT

Lorain is a dentist with $900K in cash to invest in commercial real estate. She has been looking for a commercial property in the Bay Area for the past 2 years. There are few commercial properties in the $1 million – $3 million range for sale in the Bay Area. And if there are, they tend to be very old and in an undesirable part of town with a lot of deferred maintenance and financially weak tenants. She wonders who would have the courage to invest in such a property. You cannot afford the best and most expensive properties. However, she noted many good, affordable malls outside of California with high-income, brand-name tenants. With her busy work schedule and 2 young children, taking time off just to view these properties is a major undertaking. Also, she wouldn’t know if the area is a good place to invest. She would have to find a reliable property manager and then make business decisions like who to lease the vacant space to, thousands of miles away. She thought that there must be a better investment solution.

Sunny has been working as an engineer in the Bay Area for over 15 years. Over the years, he contributed to his company’s 401K plan and accumulated more than $350K in his rollover IRA account. He notices that the return on his IRA funds is low. As he gets older, he worries about the volatility of the stock market. The recent scandals over retroactive stock options and Enron have shaken his confidence in public corporations. He now wants to use his IRA money to invest in tangible real estate where he has more comfort and control. He learns that he could put this money into a self-directed IRA to invest in real estate. As he does more research, he can use money from a self-directed IRA as a down payment. But the IRS excludes any personal guarantees for the loan, minimizing your leverage. This personal guarantee is an important restriction because all residential lenders require it. Also, a self-directed IRA without a social security number or federal tax ID is not a borrowing entity that lenders will recognize (a full article on using a self-directed IRA to invest in real estate will be presented in a future issue.) There is a solution.

What is ICT? While TIC simply means Tenant in Common, the term TIC often means a type of property in which multiple investors buy together. A real estate broker brings together a group of investors like Lorain and Sunny as an investment club to buy an income-producing property. The real estate broker is called a TIC sponsor. The sponsor is motivated to find the best property so they can promote it to investors like Lorain and Sunny. This property is often more expensive, eg $5M-$10M; therefore, most investors cannot buy individually. Lorain and Sunny are happy to invest in a good property with a good income. The TIC sponsor earns a commission on the sale and a contingent fee in the form of 10% ownership of the property. Therefore, it is a win-win situation for both the TIC sponsor and the investors. The TIC sponsor manages the property, provides a quarterly operating income and expense report, and distributes the proceeds to investors.

Investor Benefits: The concept behind TIC is “it is better to own a part of a more valuable, stable and well located property than to own 100% of a lousy property”.

  • Lorain is pleased that she is able to invest in a nice property with a good income and great appreciation potential. The property is in good hands with sponsor TIC; so you can focus on your dental business and
  • Sunny is very happy because she owns less than 25% of the property and therefore does not have to provide any personal collateral for the loan. It meets the IRS requirement and you can still maximize leverage. Your share of operating income will be deposited into your self-directed IRA.
  • Since the loan amount to finance the property is substantially higher, eg $6-10 million, and the property has superior features, the interest rate will be lower, eg 6% instead of 7%. As a result, investors will receive a better return on their investment.

operating agreement: This is a document with rules to govern the investment club that all investors have to accept. This will minimize potential disputes between investors. Some of the key rules can be:

  • Major decisions, such as selling the entire property, will require the unanimous approval of the LLC members.
  • All members own the property as a common tenant and hence the term TIC.
  • Each co-owner has a right of first refusal when any other co-owner wants to sell his part.

title under TIC– The TIC sponsor often forms a Limited Liability Company (LLC) to take title to the property. An LLC will protect the property from potential liability exposure. For example, if one of the investors is sued, the creditors cannot go after the property. This is because the investor has an equitable interest in the property but does not legally own it. The LLC is the legal owner of the property. The TIC sponsor is the administrator of the LLC, so it can make certain decisions, for example, sign the new lease on behalf of all investors.

property loan: the property normally has a non-recourse loan in which the property is the only guarantee of the loan. The lender cannot go after other investor assets in the event of a default. The lender will require all investors who own more than 25% of the property to complete the loan application. Therefore, Sunny needs to keep her ownership less than 25% because her self-directed IRA owns the property.

income tax: Individual investors can report all income on Schedule E. For example, if Lorain owns 25% of the property, she will receive an Operating Statement with information on income and expenses from the TIC sponsor. He will report 25% of income, 25% of expenses, and 25% of property depreciation on his Schedule E. For Sunny, all positive cash flow is deposited into his self-directed IRA and he defers some income .

1031 exchange: The ownership interest may be 1031 exchange ownership if the joint ownership is not classified as a partnership for tax purposes. Therefore, investors can obtain a tax deferral on a similar exchange of their fractional ownership interest.

the happy ending: TIC sponsor suggests that both Sunny and Lorain consider investing with 2 other investors in a 2-year-old, 30,900 sf, $7.9 million upscale shopping center in Lawrenceville, a prosperous and low-income city. fast growth. in suburban Atlanta, GA. The property is located across from a Walmart Supercenter; So, you both know you’re in a prime location. The property currently has a non-recourse loan of $6M at a below-market interest rate of 5.6% through 2016. So while the cap rate is a respectable 7.25%, the cash-on-cash yield is over 10%. because the interest rate is very low. After reviewing the brochure and the financial information of the property, they sign the subscription contract to go ahead with the investment.

DISCLOSURE: To ensure compliance with the requirements imposed by IRS Circular 230, please be advised that the US federal tax advice contained in this article is not intended for use or written to be used, and is not It can be used by any taxpayer for the purpose of: (i) avoiding sanctions under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter dealt with herein. This article does not provide tax advice for any specific transaction. If you would like advice on any particular transaction, please consult a professional tax adviser.

Leave a Reply

Your email address will not be published. Required fields are marked *