Carefully manage tenancy-in-common investments to facilitate smooth wealth transfer.
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
passive forms of real estate investment such as tenancy-in-common
These investors should be aware of how to determine a TIC investment's
particularly when managing their estates. Careful pre- and post-death
planning can minimize taxes significantly and facilitate smooth wealth
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.