In my last article, I described an investment tool—syndication—and how one could benefit from its utilization. Perhaps syndicating sounds appealing and you would like to know more. If that’s the case, read on and dig deeper into the little-known world of syndication.
In case you missed last week’s article, a syndication is simply a group of like-minded investors that pool their resources together in order to participate in investments larger than they otherwise would have been able to alone. In real estate applications, members within a syndication take ownership of an income property proportional to their capital contribution. Thus, if a $100,000 cash outlay is required purchase a property and syndication member Bob contributes $20,000 to the cause, he will hold a 20% interest in the property.
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How to take ownership in real estate syndications
The theory of syndication is easy enough to understand. Where things start to get tricky is during the formation of the legal entity. I will discuss some of the commonly used ones in syndications.
Tenants in Common
Perhaps the most common ownership entity used in syndication applications is tenants in common (TIC). In a TIC, title is held by each investor as tenants in common with each other. To the individual investor, the benefits of ownership are just as if he had sole ownership of the property—except he only owns a portion of it. Expenses, depreciation, and revenue are reported on the Schedule E of the investor’s tax return just as if he had sole ownership—except his reported expenses, depreciation, and revenue are limited to the proportion of his ownership. Since syndication member Bob holds a 20% interest in the property, he collects 20% of the revenue and may deduct 20% of the expenses and depreciation. Additionally, members of a TIC are eligible for IRS code 1031 like kind exchanges.
The tenants in common entity is relatively simple to form and offers many benefits. The caveat, however, is that financing can be difficult to obtain. A lender may have to qualify every member of the TIC. This can be especially problematic for large TICs. Some lenders even limit the number of people/entities that may take ownership in a property.
Limited Liability Company
Another entity commonly used in syndications is the Limited Liability Company (LLC). LLCs are popular because no member of an LLC is exposed to unlimited liability. Additionally, lenders typically only qualify the managing member of an LLC for loan approval. Unfortunately, ownership interests in an LLC are considered to be personal property and, accordingly, do not qualify for 1031 exchanges. However, the LLC itself may perform a 1031 exchange.
Some syndications are formed with both TICs and LLCs. For example, an individual performing a 1031 exchange may purchase a property via a syndication where he is tenants in common with an LLC. Let’s say Bob is performing a 1031 exchange and he finds a great replacement property—but he can’t afford it all himself. So he syndicates with “Fond Returns, LLC” and takes title to the new property as tenants in common.
Keep these points in mind as you continue to develop your personal real estate strategy. Happy Investing!