By David I. Kempler, Esq. and Elizabeth Carrott Minnigh, Esq.
Buchanan Ingersoll & Rooney PC, Washington, DC
Generally, the co-ownership of property will not result in the creation of a partnership for federal income tax purposes. However, where the co-owners enter into extensive agreements regarding the management of the property and the alienability of interest therein, the co-ownership arrangement will constitute a partnership for federal tax purposes.1 In Rev. Proc. 2002-22,2 the IRS listed the conditions under which it will consider a request for a ruling that an undivided fractional interest (i.e., a tenancy-in-common interest) in rental real property (other than a mineral property as defined in §614 is not an interest in a corporation or partnership for federal tax purposes. For purposes of §1031, it is important that co-owners of real property not be treated as partners in a partnership since a partnership interest is excluded property for §1031 purposes. In a program manager technical advice memorandum,3 the IRS Office of Chief Counsel stated that the temporary pooling of funds on a non-pro rata basis and the appointment of a payment and/or communications agent because of the bankruptcy of the master tenant did not cause the tenants-in-common to become partners in a partnership for federal income tax purposes where the tenant-in-common arrangements were not partnerships for federal income tax purposes prior to the temporary pooling of funds.
X, a company sponsoring the syndication of undivided tenant-in-common interests in rental real property, organized the sale of properties to a significant number of investors, generally individuals. In a tenancy-in-common, two or more parties hold an individual, undivided ownership interest in a parcel of property, which means that each party has the right to transfer the ownership of that party's ownership interest. The tenants-in-common may hold unequal interests in the property. In a typical transaction, X, or one of its affiliates, purchased real property for rental and then sold those interests to investors seeking to complete like-kind exchanges under §1031. Contemporaneously with purchasing the interest, the tenant-in-common owners leased the property to a master tenant, an affiliate of X, and entered a tenants-in-common agreement that, pursuant to Rev. Proc. 2002-22,4 required all owners share revenues and fund expenses related to the rental property pro rata in proportion to their relative percentage interests in the property.
Thereafter, X and several of its affiliates filed petitions for bankruptcy. The tenant-in-common owners undertook the certain actions to protect their interests, including (i) pooling funds to pay legal fees in connection with the bankruptcy and to make debt service payments, (ii) designating a payment agent to collect funds and remit to legal counsel for disbursement and (iii) designating a communications agent to act as liaison between the owners and various third parties involved in the bankruptcy proceedings.
The tenant-in-common owners initially pooled funds on a non-pro rata basis, to expeditiously pay legal fees and costs related to the bankruptcy, and to make debt service payments. The non-pro rata payments made by certain tenant-in-common owners could not be equalized within the 31 days prescribed by §6.08 of Rev. Proc. 2002-22 due to the urgency of the bankruptcy and difficulties in obtaining the information regarding the other tenant-in-common owners. The tenant-in-common owners who contributed the funds would undertake actions to enforce the equalization of payments. Accordingly, the IRS Office of Chief Counsel concluded that the tenant-in-common owners had not become partners in a partnership for federal income tax purposes even though one or more tenant-in-common owners had not made the equalization payments.
Moreover, the IRS Office of Chief Counsel concluded that, given the circumstances resulting from the bankruptcy, the appointment of a payment agent and a communications agent was not sufficiently extensive to cause the tenancy-in-common to be treated as a partnership for federal income tax purposes.5
This PMTA is of value to practitioners especially during these tough economic times when transactions may not meet the exact guidelines previously announced by the IRS.
For more information, in the BNA Tax Management Portfolios, see Levine, 567 T.M., Taxfree Exchanges Under Section 1031, and in Tax Practice Series, see ¶4020, Classification as a Partnership.
4 Rev. Proc. 2002-22 lists the condition under which the IRS will consider a request for a private letter ruling that an undivided fractional interest (i.e., tenancy in common interest) in rental real property will not be reclassified as a partnership interest. If reclassification occurred, §1031 would not be available.
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