Should you be worried about the future of tax-deferred exchanges?
many years I have written articles on the implications if tenant-in-common
interests are determined to be securities. One such concern is whether TIC
interests can be employed in tax-deferred exchanges. Historically, a taxpayer
might have exchanged TIC interests per Internal Revenue Code Section 1031, but
such a decision depended, in part, on whether the TIC interest would constitute
a property is held to be a security, it will not
qualify for a tax-deferred exchange under IRC Section 1031. Thus, a court
decision ruling that a TIC, even though it is real estate, constitutes a
security, is a very important exchange issue.
July, the Montana Supreme Court determined that a TIC is a security — a
decision that may have ramifications for commercial real estate investors and
advisers who have participated in tax-deferred exchanges where TIC interests
What Is a Security?
Act of 1933, a security can constitute notes, stocks, evidence of indebtedness,
and a number of other items, including what has turned out to be the very
important label of an “investment contract.”
term investment contract
was created in the 1933 statute, but not defined until 1946 when the U.S.
Supreme Court decided the case of SEC v. W.J. Howey Co. That ruling created the
Howey test of the four necessary elements for an investment contract: an
investment of money or other property; a common enterprise; an intent to make a
profit; and the intent to use the expertise of someone other than the
recent TIC securities decision is from the Montana Supreme Court case of Billie
L. Redding v. Montana First Judicial District Court.
Redding, an elderly widow who had worked on the family ranch for most of her
life, sold the ranch in 2004 for $3.3 million. To avoid tax liability on the
sale, Redding was guided to enter into a tax-deferred exchange transaction.
relied on the advice of her longtime accountant who was a shareholder in the
accounting firm Anderson Zur-Muehlenn & Co., P.C. He guided Redding to
invest in TIC interests in a separate entity known as DBSI Housing. Redding
purchased four TIC interests in 2004, via a tax-deferred exchange. The Redding
interests were brokered by Acquiron, a subsidiary of Anderson ZurMuehlenn. She
paid about $4.6 million for the TIC interests, contributing her real estate
equity position of approximately $2.2 million and assuming debt of about $2.4
DBSI collapsed, and in 2008, it filed for bankruptcy. A receiver determined
that there was a Ponzi scheme involved. After the DBSI collapse, Redding
brought action against Anderson ZurMuehlenn, alleging unlawful sale of
securities, among other counts. She sought general damages of more than $4.6
million plus punitive damages.
that there was no common enterprise between DBSI and Redding, the Montana First
Judicial District Court found that the DBSI TIC interests were not securities
under Montana law. Redding asked the Montana Supreme Court to review to case.
Supreme Court said it defines a security quite broadly. It cited various authorities, such as the
1979 Montana securities case State v. Duncan.
Supreme Court said: “…we conclude DBSI’s TIC investment scheme was a common
venture under any measure.” It cited the Howey decision and noted how the
factual circumstances are important, concluding “… in reality DBSI sought out
passive investors and that Redding, regardless of the rights she retained in
the written agreements, was not expected to exercise any meaningful control
over her investment, nor did she expect to exercise meaningful control over her
ZurMuehlenn argued that under Revenue Procedure 2002-22, the TICs were not
the Supreme Court of Montana made one of the strongest findings in any decision
on this issue: “[Anderson Zur
Muehlenn], however, has not shown that in 2004 the IRS or anyone else believed
that the TICs were not
securities. Revenue Procedure 2002-22 simply provides guidance for TIC sponsors
and owners to avoid having TICs classified as partnerships. It
does not say TICs are not securities.”
Supreme Court of Montana, therefore, concluded that the statement by Anderson
ZurMuehlenn that the TICs were not securities in 2004 is incorrect: “TICs would
have been considered securities in 2004.”
the Supreme Court of Montana stated the foundation of its important decision:
“Based on the tests and principles of law discussed above, the TICs here are
Redding decision means that a TIC in this setting can be a security. This means
that there are many areas of potential liability for many advisers who, as
attorneys, CPAs, real estate brokers, or otherwise, have counseled their
clients that the transaction was not a security.
Lee Levine, CCIM, JD, LLM (tax), is a professor
and past director of the Burns School of Real Estate and Construction
Management, Daniels College of Business, University of Denver. Contact him at