In 2002, the IRS released Revenue Procedure 2002-22 containing long-awaited guidance on undivided tenant in common ownership of property under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Code”). Unlike the “safe harbor” that was expected, the guidance takes the form of advance ruling requirements. While not a statement of substantive law, the advance ruling requirements are likely to become a litmus test for many sponsors of tenant in common replacement property programs.
In Revenue Procedure 2000-46 (October 12, 2000), the IRS stated that it would no longer issue advance rulings on whether an undivided (fractional) tenant in common interest in real property is an interest in an entity that is eligible for tax-deferred exchange treatment under Section 1031. The IRS was concerned that taxpayers were taking the position that certain arrangements where they acquire tenant in common interests in real property may constitute an interest in an entity classified as a partnership for federal income tax purposes. Revenue Procedure 2000-46 has now been repealed. A copy of Revenue Procedure 2002-22 is attached.
The advance ruling guidelines are set forth in Section 5 and the conditions to issuance of a ruling are set forth in Section 6. The Revenue Procedure states that the IRS “ordinarily” will not consider a request for a ruling unless the information described in Section 5 is included and the conditions described in Section 6 are satisfied. However, even if Sections 5 and 6 are satisfied, the IRS may decline to issue a ruling “whenever warranted by the facts and circumstances of a particular case and whenever appropriate in the interest of sound tax administration.” This will create fertile ground for creative sponsors of tenant in common programs and their able tax counsel.
Section 5 outlines the information to be submitted as part of a ruling request, including detailed information on each co-owner and the property. In addition, the ruling request must contain a complete statement of all the facts relating to the tenant in common ownership, including those relating to promoting, financing and managing the property. All of the following information must be included to the extent related to the property:
All documents and supplementary materials submitted to the IRS must contain applicable exhibits, attachments and amendments. Keep in mind that rulings will only be granted for “real” (and not hypothetical) deals. However, much of the required information may only be known at the end of an offering, when the sponsor is ready to acquire the property, close the loan and sell interests to the tenants in common. Accordingly, it is unlikely that many sponsors will be able to keep a deal open long enough to obtain a ruling.
The IRS “ordinarily” will not consider a request for a ruling unless the conditions described in Section 6 are satisfied. However, where the conditions in Section 6 are not satisfied, the IRS still may consider a ruling request “where the facts and circumstances clearly establish that such a ruling is appropriate.” The conditions are summarized below.
In conclusion, the IRS may now render advance rulings on tenant in common programs. However, very little new guidance has been given on the difference between a qualifying tenant in common interest and a non-qualifying interest in an entity. Also, there is no mention of the much anticipated master lease programs.
The conditions stated above are understood and being followed by many sponsors of tenant in common programs. However, the IRS retains the authority under appropriate circumstances to decline to issue a ruling. The absence of a “safe harbor” or other bright line test will create fertile ground in the future for creatively structured tenant in common programs. Apparently, the IRS decided to defer the hard questions to the future, when ruling requests are received and considered.
Therefore, those interested in tenant in common programs will need to wait for guidance to follow from the IRS in future rulings and, possibly, announcements. Until then, sponsors of tenant in common programs are likely to adapt their programs to conform with most of the conditions stated in the Revenue Procedure. However, sponsors of other programs, for example, those that make use of a master lease or election out of Subchapter K, are free to continue offering their programs because the Revenue Procedure is not a statement of substantive law and not to be used for audit purposes.
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