Tax issues

Splitting Heirs

Carefully manage tenancy-in-common investments to facilitate smooth wealth transfer.

By Howard Kass, CPA |

Strong market fundamentals and low interest rates have opened the world of commercial real estate to a whole new pool of investors. Seeking alternatives to the stock market, many investors have ventured into passive forms of real estate investment such as tenancy-in-common interests. These investors should be aware of how to determine a TIC investment's basis, particularly when managing their estates. Careful pre- and post-death estate planning can minimize taxes significantly and facilitate smooth wealth transfer to TIC investment heirs.

A TIC ownership interest in real estate can be purchased, sold, gifted, willed, or inherited, and is subject to income, gift, estate, and inheritance taxes in the same manner as any property held in fee-simple ownership. Upon the death of a tenant in common, his or her interest in the property passes through inheritance as directed in the investor's will or other estate planning document. The interest does not divide among the other existing TIC owners, as there is no right of survivorship. Unlike property held in joint tenancy with rights of survivorship, TIC interests do not avoid probate. However, TIC ownership has different purposes and uses, and there are advantages to using it as an investment vehicle.

Potential Tax Advantages

From an estate planning perspective, TIC investors' heirs benefit from multiple tax advantages upon inheriting such property. TIC investors holding appreciated property not only may avoid capital gains taxes by holding the property until death, but the heirs also may gain tax advantages through a stepped-up basis in that property, resulting in additional depreciation deductions. In addition, the higher basis results in lower taxable gains upon the sale of that property.

Determining Fair Market Value

As is the case with any asset held at death, a TIC investment is appraised at fair market value the day the investor dies or at the alternate valuation date of six months after death as allowed by the Internal Revenue Code. Moreover, if an estate's asset value has declined as of the alternate valuation date, the taxpayer may file the return based on that lower valuation, resulting in a lower estate tax assessment. This provision prevents penalizing an estate whose value spiked just prior to death or declined following death by providing a mechanism to assess the estate tax based on the lower value.

Should the property be sold shortly after the investor's death, it is likely no capital gains will be realized on the sale because the appraised value at the time of death is the new basis used to determine capital gains or losses on the TIC sale. This stepped-up basis, or value of the property at the time of death rather than the time of purchase, is a potential income tax advantage in that it may significantly reduce the overall capital gain on the eventual sale of the property.

Consider the Heirs

Transfer of wealth allows significant tax advantages when bequeathing TIC investments to surviving spouses and charities. Once a TIC investment is passed on to heirs, they can elect to sell the property and realize a significantly lower taxable capital gain, if any, than if the property had been sold by the decedent. The other option is to hold onto the TIC for a number of years before selling. The basis for determining any gains is the stepped-up value on the date of death less any depreciation deductions taken subsequent to inheritance.

The TIC can be bequeathed to one or more heirs through the use of a trust, a limited partnership, or a limited liability company. These entities are not required; they simply are tools that can be used for a number of estate or business planning purposes in directing the transfer of wealth in the estate.

It may be important for the health of heirs' relationships to consider that TICs are not liquid investments. Thus, TIC owners need to consider if the heirs will be appropriate owners. For instance, does the heir understand the investment? Is he or she going to need the cash from the investment soon? If a TIC interest were held in an LLC by three or four relatives, each one would have to negotiate with the other entities in the LLC to buy out their interest.

Planning in Advance

There are two goals to achieve when planning an estate: Minimize taxes and get the property into the intended heir's hands with the highest possible basis from which to calculate future capital gains. Unfortunately, the two goals more often than not are in conflict with one another. For example, titling a TIC in a single-member LLC could allow the owner to give away interests in the LLC before death as an estate reduction tool. In this scenario, the owner is looking to reduce the estate's taxable value by giving it away in little chunks, gifting those interests and using various valuation discounts. For example, if 25 percent of the interest in a property is given away pre-death to minimize taxes on the estate and the remaining 75 percent is included in the estate to be passed on after death, the 25 percent is passed on to heirs with a carry-over basis and the 75 percent remaining after death receives a stepped-up basis.

The 2010 Question

What about the magic year 2010 when by law all estate taxes are supposed to vanish? Should investors plan around that year? The answer is probably not. It is reasonable to expect that Congress substantially will change the estate tax law before 2010, which likely will affect the proposed repeal. It is wise to advise clients to prepare their estate plans based on current tax laws and to make adjustments to their plans as the laws change. Investors should seek the assistance of a qualified tax consultant when formulating an estate plan to minimize their tax burden and to gain a complete understanding of how tax laws affect their plan.