Most people think of an orchestra as a group of musicians who play together for a season or longer. The New York Philharmonic, the oldest symphony orchestra in the United States, dates to 1842, and musicians perform together for years. Although the current concertmaster, Frank Huang, has "only" held his position for six years, his predecessor, Glenn Dicterow, was concertmaster for 34 years.
But not all orchestras boast that history or longevity of membership. The League of American Orchestras has five classifications for orchestras. Class A orchestras, like the New York Philharmonic, have large budgets and the highest level of professional musicians, and Class E orchestras have non-professional musicians and small budgets. Classes B, C, and D are in between.
Orchestras also can be categorized by whether they are full- or part-time or year-long, or seasonal. There are orchestras that assemble only in the summer for a music festival and even for a few weeks for the holiday season.
And there are pick-up orchestras. These orchestras are comprised of free-lance musicians who don’t regularly perform together. As a student, I made extra money performing in pick-up orchestras that played the backup track for live performers that came to two or were the pit orchestra for a musical performance.
Most musicians in a pick-up orchestra don't plan to work together regularly; they end up together by the circumstances of hearing about the gig and being available. After their performances, they go their separate ways and may never perform together as an orchestra again.
Real estate investments also can be classified. For example, there are highly professional, high-value real estate funds managed by experienced sponsors and property managers. Other individuals may buy a few duplexes or four-plexes as a side gig and self-manage.
When it comes to tenant-in-common real estate (TICs), there are professionally-managed TICs assembled by a sponsor and sold to investors, usually to facilitate section 1031 exchanges. These TICs include a tenant-in-common agreement (TIC Agreement), which outlines the parties' rights and responsibilities. Usually, a TIC Agreement also will include provisions designed to comply with Rev. Proc. 2002-22, which describes when TIC investments are eligible for Section 1031 like-kind exchanges under federal tax laws.
There are less formal TICs, which I’m calling “accidental” TICs. This article discusses these “accidental” TICs, the pitfalls of this type of TIC ownership, and best practices for individuals who find themselves in an “accidental” TIC.
What is an “Accidental” TIC
“Accidental” TICs are created most frequently when real estate investors or homeowners die without specifying ownership of their real estate in their will. The result is several family members sharing ownership of the real estate as TICs.
Other times, several friends may intentionally invest in a rental property or beach house together. Although they intend to buy property together, they don’t necessarily intend to create a TIC, so they don’t sign a TIC Agreement. So for this article, I’m also considering these “accidental” TICS.
Practical Considerations for “Accidental” TIC Ownership
All TIC ownerships share similar management and operational concerns. However, with a sponsored TIC offering, a TIC Agreement outlines the parties' rights and responsibilities. And the sponsor takes on the role of a "traffic cop" to direct the TICs and facilitate operations.
“Accidental” TICs have many of the same management and operational concerns. Issues include:
Paying Expenses – Inherited “accidental TICs” may be owned free and clear, but someone has to pay the real estate taxes, insurance, utilities, and maintenance costs. Investment property might receive rent that produces cash flow to pay these costs. But who pays them if there is no tenant, as might be the case with a family beach house? What happens if one TIC can't contribute, and another pays their share?
Banking and Management – Someone needs to manage the property. Besides paying the bills, someone needs to arrange for repairs and maintenance, cleaning, and renting the property. Will there be a professional management company, or will one of the TICs manage the property? If one of the TICs takes on the task, how will they be compensated?
How and By Whom Will the Property Be Used? – The owners need to decide whether the property will be rented or occupied by the owners. For a vacation home, this could require agreeing on how many weeks each owner can use the home – and how gets to use it during peak vacation times. If the property is to be rented, the owners need to agree on the rental rate and other rental terms (i.e., will there be a minimum number of days?), including where the property will be listed.
Ownership Percentage -- When parties buy property together, they must agree on their respective ownership percentages. Usually, if the owners don't specify percentages in the deed, they all will be considered to have equal ownership. If this isn’t what the parties want, they need to address it on a deed.
Repairs, Maintenance, and Capital Expenses – Some repairs and maintenance are obviously needed. There’s no question about replacing a malfunctioning water heater or furnace. But other repairs that are more like upgrades, such as installing smart home or energy efficiency features, can cause disputes. And even for necessary maintenance, there can be disagreement. For instance, one TIC might want a solar or on-demand water heater, but another might want the less-expensive traditional tank heater. Plus, there may be disagreement about additions, expansions, and upgrades. How will these issues be resolved?
Transfer of Ownership – Eventually, one of the TICs will die, get divorced, or run into financial difficulty. What happens if a lien is filed against one TICs’ interest? And the other TICs might not want to own the property with heirs or an ex-spouse or creditor they don’t know well. Or the other TICS might not want to get embroiled in divorce or bankruptcy litigation.
Sale of the Property – Whether for financial reasons or lifestyle changes, at some point, one or more of the TICs may want to sell the property. How will the TICs decide when to sell? What happens if not everyone wants to sell? Everyone will need to sign the deed to convey the property.
What if there Isn't Agreement?
Unfortunately, owners of “accidental TICs” may have differing objectives. They also may have no incentive to be reasonable or even to sign an Agreement.
In most jurisdictions, if there isn’t a TIC Agreement, each TIC will own an equal share unless the deed specifies otherwise. And each TIC’s heirs can inherit their share. For inherited property, by the time the grandchildren of the original owners assume ownership, there could be more than a dozen owners.
I recently experienced this with my own family. One family member died without a will, leaving 18 of my extended family members with the rights to various percentage of a parcel of real estate. I’m blessed with a cooperative and close extended family (and I’m an attorney). We agreed to sell the property and split the costs and proceeds according to the law of inheritance. But most families aren’t as fortunate.
If some family members want to sell but others don’t, they can file a lawsuit asking for "partition" to split the land. A partition action usually forces the owners to sell. But it costs money to file a lawsuit. Family members may not have the money to do this, and a lawsuit might only expand a family rift.
More frequently, the family members who can't agree just passively hold onto the property. Maybe one family member lives there and pays the property expenses, only to be upset when the others eventually want to kick them out after years of carefully tending to the property. Other times, no one takes care of the property. It can become a blight in the neighborhood. The owners may be cited for code violations and eventually be sold for taxes.
Best Practices for TIC Ownership
Although members may treat TIC-owned property casually, TICs aren’t like temporary pick-up orchestras. It’s challenging to sell jointly-held real estate, so once someone buys real estate, they are usually in for the long haul. Even an orchestra as prestigious as the New York Philharmonic experiences personnel changes. However, even with Class A orchestras, musicians may retire, die, or want a change.
Similarly, every TIC owner group eventually will experience change as the owners’ life stages and objectives change, or the property is passed to the next generation. Therefore, every group that owns property as a TIC should have a TIC Agreement – even siblings who inherit or two couples who buy a vacation property and share the expenses 50/50.
The best time to prepare a TIC Agreement is when the owners first buy the property. That's when their objectives are most likely to be aligned (and negotiating a TIC Agreement can help them unearth any fundamental differences that might dissuade them from buying property together).
A good TIC Agreement will address the issues described in this article and be recorded in the county real estate records to bind future owners. In addition, an attorney experienced with TICs can help them create an ownership structure and terms that reflect the owners' objectives and optimize tax treatment of their ownership.
This series draws from Elizabeth Whitman’s background in and passion for classical music to illustrate creative solutions for legal challenges experienced by businesses and real estate investors.
