Since we’re in a buyer’s real estate market, I got to thinking about all the dialogue that takes place concerning the best vehicles for real estate investing, and it brought back a memory. You may or may not know that David, Ryan, and I previously worked at a former OSJ branch of Omni Brokerage, called JRW Investments. Well during my tenure there, while attending a trade show with the Registered Reps, I had the opportunity to hear “Rich Dad, Poor Dad” author Robert Kiyosaki speak. And amid all of the helpful insight and motivation, he spewed forth the following oversimplification with positivity and absolution, which I was only subsequently able to attribute to his advisor, Garret Sutton:

a limited liability company (an LLC) is the best entity for [real estate investing] business.[1]

Why? Sutton went on in the article I had tracked down, which was posted to the internet at the time, to describe the benefits of LLC’s for owners, including “excellent liability protection, flow-through tax treatment” and the “ability to transfer real estate”. These benefits were directly contrasted to other vehicles of holding real estate, including “Tenant-in-Common“!.

Much of what he said may have been true, but it was unfortunately oversimplified, and had a regrettable effect on us as a result. Can you guess what happened at that trade show after all of those aspirant real estate investors heard Rich Son’s rant against Tenant-in-Common as a method for holding real estate? They all came flooding out of the auditorium to see JRW Investment’s booth proudly advertising TIC investments as replacement properties for 1031 exchanges! Robert Kiyosaki had turned off half of his clientele (ticket-purchasing investors) to the other half (sponsorship-purchasing vendors)!

So what of taking title to real property as a Tenant-in-Common? TIC investments have become popular since IRS revenue procedure 2002-22 blessed them as viable replacement properties for 1031 tax-deferred exchanges. So popular in fact, that an entire industry has blossomed that focuses on bringing TIC properties to investors looking for passive cash flow. Do TIC investors have to abandon the benefits of LLC’s entirely?

Fortunately the answer is “no”, investors don’t have to chose: most Lenders who finance portions of these TIC offerings actually require Sponsors to set their investors up to take title to their interests via LLC’s. These Single Purpose Entities (SPE’s) are disregarded for federal tax purposes, which means the liability protection offered by LLC’s can be utilized without fear of fumbling the exchange.

A voice from within the TIC industry, Margustin Born, Director of Investment Programs at Meridian Realty, wrote that

The use of SPE’s provides two major benefits to TIC investors. First, it insulates them from financial risks associated with financial problems of their fellow investors. Second, it limits their financial exposure to the amount of equity they have invested in the transaction.[2]

But while these benefits can be utilized even when investing in real estate as a Tenant-in-Common, a challenge regularly faces the industry. Although most TIC Sponsors have these LLC’s Formed as a part of their investment packages, many TIC properties sustain Delinquencies. During a month-long survey, Sabre uncovered that a whopping 80% of the properties in a generous sample each had at least one Delinquent investor LLC.

As it turns out, Delinquent LLC’s aren’t just problems for their individual owners, either. Delinquent LLC’s can inhibit a Sponsor’s ability to bring legal action against building occupants who violate their lease agreements. The LLC’s also lose their Authority to Do Business, cease to limit investor liability, and may bring the various loans into default.

To fully take advantage of the benefits that LLC’s bring TIC investors, Sponsors and investors must take measures to ensure that a Registered Agent remains appointed to their entity, and that all state tax and Filing requirements are met. Only then can the false dichotomy pitting TIC against LLC be resolved, allowing real estate investors to enjoy the limited liability of the one, with the tax-deferred exchange potential of the other.

1 Garret Sutton, The Best Entity for Hold Real Estate. Articles, CASHFLOW Technologies 2006, Retrieved July 18th, 2007.

2 Margustin G. Born, Making Sense of the Legal “Mumbo Jumbo” – A TIC Investors’ Guide to SPEs. TIC TALK 2nd Quarter 2007, OMNI Consulting & Research. Available online.

“TIC”, as a term, is profligate: it is used in many different ways.  Its profligacy is here ruminated upon.

The term can be used to refer to a kind of investment, a kind of property, or a kind of investor.

TIC Investment

Most often “TIC” is used to refer to the Tenant-in-Common investment itself.  A TIC Investment is, in essence, a way of owning real estate, sometimes referred to as “fractional ownership”.  Under this method of taking title to real property, each investor is a co-owner of the property, owning an “undivided fractional interest” in the whole.  A main reason why this kind of investment is popular is that, since it can count as a “replacement property” in a 1031 exchange, it may be used to defer capital gains tax.  (More about this here.)

TIC Property

Sometimes “TIC” is used more loosely to refer to the property that is being taken title to.  So, for example, if the object of a given TIC investment is a skyscraper in Chicago, one might say “The TIC is in Illinois, so we’ll need to be Qualified to Do Business in that state.”

I can think of two possible linguistic explanations for this naming practice.

The first, and most interesting explanation, is that this nomenclature might be due to the unintentional use of the figure of speech known as synecdoche, in which “something is used to refer to the whole (and vice versa)”.  An example of unintentional synecdoche is the trend to refer to the clock tower at the Palace of Westminster as “Big Ben”, where, actually, Big Ben is the name given to largest of the clock’s bells, and the clock tower is simply called “the clock tower”.  In this example, the name for a part of the object, (the big bell) is used to refer to the object itself.  The inverse of this, in which a whole is used to refer to the part, is also a case of synecdoche, called “totum pro parte”.  Any given property may be the object of an investment,  and therefore, in a sense, a part of the investment, but the investment itself is distinct.  Investments are financial arrangements; real estate properties are areas of land, sometimes with buildings on top of them. Different things. So, to call the property the “TIC” may be to play slipshod with our terms, calling a part of the investment by the investment’s name.

The second and more natural explanation is that “TIC” is just short for “TIC Property”.

TIC Investor/TIC Entities

Sabre has more occasion to refer to individual investors, or, more specifically, individual legal entities used by individual investors, by the term “TIC”.  Investments, surprise surprise, have investors.  Tenant-in-Common investments can have up to 35 individual investors, all taking part of an undivided fraction of the property. Lenders require that each of these investors takes hold of their portion of a TIC investment by means of a Single Purpose Entity, typically a LLC (for more on this, see here).

These LLC’s, which Sabre can Form and Maintain on behalf of Sponsors, are named in such as way to reflect that their sole function is a vehicle for Tenant-in-Common investors to take hold of their interest of the investment.  Sabre deals with thousands of such entities.  Accordingly, seeing scores of legal entities all with “TIC” in the name, a natural linguistic evolution is to call the LLC’s just that: TIC’s.

TIC investments are the mechanisms by which TIC properties and TIC investors come together.  Or, to put it recklessly, TIC’s are the means by which TIC’s invest in TIC’s.

Now, alas, there are twice as many reasons to File the DE Franchise Tax on time.  Delaware is set to increase its LLC fees, including the Franchise Tax Late Penalty (along with sundry other corporation services, such as Certified Copies, Amendments, and Cancellations).  The fee is to increase from its present $100 figure, to $200.  This spike in fees is scheduled to take effect as of August 1, 2009, as described by House Substitute No. 1 for House Bill No. 267, which has been passed into law by the Delaware Legislature.

Many LLC’s are Formed in Delaware (as we’ve noted before, there is good reason to do so).  But in Delaware, should you fail to File your Annual Report and to submit your Franchise Tax payment by the Annual Delaware due date of June 1st, your LLC will incur a late penalty and monthly interest with the state.  Different states exact different late fees with different terms, but in Delaware late entities suffer an initial late penalty of $100, with 1.5% in compounding interest.

Now, if having become subject to late penalties and interest in Delaware, you then decide to pay just your $250 in Franchise Tax payment online, as you would regularly, it turns out Delaware just won’t let you!  Once an LLC has incurred late penalties and interest in Delaware, all of the amount owed must be payed before the state will accept the Annual Report, and thereby declare the entity as being in Good Standing.  It’s all or nothing.

Now here’s the tip: 

Delaware does accept partial payment on an account if it is submitted to the Secretary of State by postal mail.  So, if for whatever reason you wanted just to pay the $250 amount, you can send mail in this payment rather than paying it online, and Delaware will accept it.

There’s good news and bad news concerning this peculiarity with Delaware.  

The bad news is that Delaware won’t, upon receiving payment for just the Franchise Tax, thereby declare your LLC in Good Standing.  As long as the entity owes money, it will stay in Delinquent status.  So, in one sense, making partial payment is fruitless.

The good news is that the 1.5% interest applies just to whatever is owed.  So, by paying off part of the entity, you decrease the amount you will end up owing in interest.  So, broadly construed, if you can’t pay everything due to Delaware immediately, it’s not wholly fruitless to mail in what you can.

Almost all of the TIC Sponsors with whom Sabre works choose to Form LLC’s in Delaware.  The Delaware entities for a given TIC property are then Qualified to Do Business in the state jurisdiction where the property resides.  What’s the motivation for this?  Why not cut out the middle man and just Form the entities in the state of the property in the first place?

One reason often cited is that Delaware lets one Form entities anonymously.  This is something unique to Delaware, but what makes this so valuable?  Why would someone want anonymity anyway?

Apart from the usual unsavory reasons why one might desire anonymity, the biggest benefit to the anonymity one enjoys with a Delaware LLC is that it cuts out administrative and financial hassle.  Because Sponsors may Form anonymously if they wish, they are furthermore not obligated to Amend their entity’s filings.  With many other states, whenever there is a change in manager or member information (such as mailing address), the LLC must be Amended with the state to reflect this change.  This means more paperwork and more fees.  When dealing with hosts of investors altogether, such minor annoyances add up.  Forming in Delaware, however, provides one with genuine anonymity, the crowning perk of which is the avoidance of so much nasty bureaucratic red tape.
 
Also, when you consider the role LLC’s play in TIC investments, it becomes apparent how anonymity provides a Sponsor flexibility as they work to bring a TIC to market.  When a Sponsor puts together a TIC Investment, they are accomplishing a masterpiece of orchestration: they are gathering into a single investment up to 35 distinct investors, most of whom are working within their own 1031-exchange timeframes.  Things get complicated. 

So, it is beneficial to Sponsors to be able to create many LLC’s up front, before they even have investors who need them.  This way, the Single Purpose Entities are primed and ready as means for the investors to take hold of their interests in the TIC property.  But if to Form an LLC the Sponsor has to have all member information on hand, (i.e., the investor’s name and address) then this option just isn’t possible.

So, Forming entities anonymously helps (1) to sidestep bothersome forms and fees, and (2) affords Sponsors a way of creating entities up front and then assigning them to investors after the fact, which in turn works to make TIC investments more viable.

1. Formation

First, an LLC is Formed. The state jurisdiction in which the LLC is Formed is called its “Primary” or “Domestic” jurisdiction.

2. Qualification

Next, the LLC is immediately Qualified to Do Business in all the jurisdictions in which it will be operating. The jurisdictions in which the LLC is Qualified are called its “Secondary” or “Foreign” jurisdictions.

3. Registered Agent

As a part of the acts of Formation and Qualification, the LLC appoints its Registered Agents, who physically reside within the borders of each of its jurisdictions. Registered Agents are appointed to receive important documents such as Services of Process when the LLC is a party in a legal action such as a lawsuit.

4. Annual Maintenance

According to the requirements of each jurisdiction, the LLC must typically file Annual or Biennial Reports, and remit fees to the Secretaries of State in each of its jurisdictions.

5. Cancellation & Withdrawal

Finally, if an LLC is no longer to be used, it is Cancelled in its Domestic jurisdiction and Withdrawn in all of its Foreign jurisdictions.

If you are visiting our website and don’t quite seem to understand what’s going on or what it is exactly that we do, this post is for you. 

Sabre Forms and maintains the “Limited Liability Companies” used in a niche real estate industry. Below is a very brief introduction to this industry and an explanation of how our LLC services fit into the picture.

A “1031 exchange” provides a real estate owner with the opportunity to relinquish a property without having to pay capital gains taxes, if he or she acquires a property of like kind according to certain rules. 

These rules are laid out in IRC section 1031 (hence “1031 exchange”). 

“Tenant-in-Common” references a certain way of taking title to real estate in which multiple owners possess undivided interests in a single property. 

In 2002, the IRS declared that Tenant-in-Common properties are valid replacement properties for 1031 exchanges. 

Since then, certain real estate companies (called “Sponsors”) have begun purchasing institutional-grade properties in order to enhance their values and resell them to investors as Tenants-in-Common. 

“TIC” investments are valuable to real estate owners interested in getting rid of their current properties in exchange for investments that they do not have to manage themselves. TIC properties centralize the resources of their investors so that a property management company can be put in place. 

The rules by which TIC properties qualify for 1031 exchanges are laid out in Rev-Proc. 2002-22. 

Each investor takes title to his or her replacement property by way of a Limited Liability Company. The investor is the single member of this LLC, and the single purpose of the LLC is to hold his or her title to the TIC interest. 

This LLC mitigates the risk of the investor’s entire asset base becoming susceptible to litigation. Usually the LLC’s used in a given TIC property are set up beforehand, as a part of the whole investment package. 

TIC Sponsors contract with Sabre to Form these LLC’s and keep them compliant with state law. We focus entirely on the compliance of the LLC’s used in TIC offerings. We streamline all of the LLC Formation and maintenance processes such that a Sponsor company can painlessly integrate our services into its offering and receive a single invoice, and zero headaches.

Welcome to Sabre’s Corporate Compliance blog.  A big thanks goes out to the Coeur d’Alene blog designer who set this all up for us, as well as the Coeur d’Alene programmer who certified that our website is free from malicious programming, and the Coeur d’Alene webdesign and SEO group with whom we consult on a regular basis!  You have been a huge help.

This blog will be like Sabre’s newsletter – we will talk about Frequently Asked Questions, Corporate Compliance news, TIC/1031 Industry news, company news, and more.  You can subscribe to this bog with an RSS reader of any kind, or by email (please see the information in the bottom of the sidebar on the right).  Feel free to leave us questions or comments!