5 Reasons You Should Have a Tenant in Common Agreement
Before You Become a Tenant in Common, Here Are Five Reasons You Should Have a Tenants-in-Common Agreement
Two or more owners of real property can hold their interest in a number of ways. The most common ways include as joint tenants, as tenants in common, or through an LLC (limited liability company). While the tax considerations of each form of holding interest are beyond the subject matter of this article, at GHP we often see tenancy-in-common arrangements when the ultimate goal is to sell the real estate through a transaction that is eligible for an Internal Revenue Code Section 1031 tax-deferred exchange.
Should you choose to enter into a tenancy-in-common arrangement, the need for a tenants-in-common (TIC) agreement is critical. If you learn only one thing from reading this article, it should be that you should never become a tenant in common unless you have entered into a TIC agreement. There are a variety of reasons you should always have a TIC agreement, including the five listed below.
Secure the Right to Freely Transfer or Encumber Your Interest
Under common law, tenants in common may unilaterally transfer or encumber their interest in the property. Furthermore, there is no right of survivorship, unless you have a contrary agreement, in a tenancy-in-common arrangement. Rather, each tenant in common may pass their interest in the property to their heirs and devisees. Knowing that on any given day you may have a new co-owner of the real estate whom you may not work well with or cannot trust should give you pause. However, a TIC agreement can help alleviate your concern by requiring that any transfer of interest be subject to a right of first offer or a right of first refusal for the nontransferring owner(s).
Specify the Rights to Occupancy of the Property
Each tenant in common has a right to occupy the whole of the property. As a result, unless there is an agreement to the contrary between the tenants in common, no tenant in common may exclude any other owner(s) from any part of the property. This default rule can be particularly problematic when the property is owned for investment purposes, and it is the intent that none (or only some) of the owners occupy the property. To address this issue, the owners can enter into a TIC agreement that sets forth superseding rules regarding each owner’s right to occupy the property.
Define the Terms of Management
Business disputes often arise because parties do not take the time to discuss their expectations and obligations before going into business together. A TIC agreement will naturally force the parties to discuss these issues early on. A TIC agreement can be crafted to cover various terms, including how the property will be managed, how group expenses are paid (e.g., from monthly assessments, capital calls, or initial contributions), whose consent is needed to sell or encumber the property, and how disputes between the owners will be resolved. Not only is it helpful to have these terms memorialized and agreed to before a dispute arises (when calmer minds typically prevail), but it also forces the owners to have honest (and sometimes difficult) conversations, helping to avoid surprises and clarify objectives.
Limit Partition to Avoid a Forced Sale
Tenants in common are generally entitled to bring an action for partition of the property. Partitioning is the division of property held by owners into distinct portions so that each tenant in common owns a separate portion of the property. Partition actions are generally filed when at least one of the owners no longer wishes to maintain the tenancy-in-common arrangement. However, quite often it is not possible or reasonable to divide a piece of property, and in such instances, the court can require that the owners sell the entire property instead. As can be expected, forced sales commonly result in an economically unfavorable outcome for the owners. With a TIC agreement, the risk of a partition action can be limited by requiring each owner to first offer their interest to the other owner(s) before any owner can file a partition action.
Satisfy a Lender Requirement
If your tenancy in common plans to finance the property via debt, lenders may require, in order to better protect their investment, that the owners enter into a TIC agreement that, among other things, limits an owner’s ability to file a partition action.
If you are interested in learning more about tenants-in-common agreements or other matters relating to commercial or residential real estate, please feel free contact us.
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