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TIC real estate investment: how would you report a loss?

Technical topics regarding tax preparation.
#1
ode923  
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Thanks in advance to anyone who has advice or who knows about "TIC investments". I've seen them before, but this is the firs time I've encountered one that has been sold at a loss.

For those who don't know about them, they are a method for small investors to pool money together, with the help of an investment sponsor, to invest in real estate, like a large commercial rental building. The benefit is the IRS doesn't consider such arrangements to be a partnership, so it therefore qualifies as eligible for a 1031 exchange. The TIC owners report their share of income and expenses on Schedule E.

My question isn't about section 1031 (which virtually all IRS guidelines and articles and instructions are about). It's about how to report the sale of a TIC syndicate interest on the trust's tax return when that sale results in a loss.

Here's are the facts:

1. The trustee of an irrevocable family trust came to me recently. The trust had one activity: it bought into a TIC syndicate. This happened in 2010. The TIC was for a commercial office building.

2. For the trust's share, the trust put up about $200K in cash and $600K in mortgage.

3. The TIC owners all had a management company that runs things with respect to the actual management of the office building. It was a very "hands off" type of deal. The TIC owners had no active involvement, mainly because they delegated everything to the sponsor and management company. Plus, I assume the commercial tenants were all on triple-net leases.

4. The TIC syndicate never made money. It always lost money, and built up passive activity losses on the tax returns for 2010, 2011, 2012, 2013, and 2014.

5. Fast forward to 2015. The building gets foreclosed on, and the court enters a final judgment. At that time, the trust had about $550 in mortgage debt still that was effectively cancelled. As far as I can tell (I don't have perfect records on this), the mortgage was a non-recourse mortgage. Therefore, the cancellation of debt is basically treated like a sale where the "proceeds" equals the cancellation of debt "income." In this case, that results in a large loss ($200K, when factoring in depreciation).

6. I didn't do any of the tax returns during those years (2010 to 2018). The trust still has some cash that the trustee is going to distribute the trust to the beneficiaries, and terminate. There are a dozen beneficiaries.

7. When I looked at the 2018 tax return, I was surprised that there was no carryover capital loss. So I asked for the prior year returns. Sure enough, in 2015, the foreclosure event was not reported.

8. The trust has never had any other income, other than small amounts of interest on the remaining cash.

My question: is it worth to amend the 2015 return to report the $200K loss from the foreclosure? If so, you have two options to report it: Option A, report it on 4797 because its a business capital loss. Option B, report it on 8949 because it's an investment loss.

I've asked this question to a few different tax professionals, including a couple from this forum. Most say they would go with option A. I seem to be in the minority and argue for option B.

Option A: Report is on 4797 because it's a business capital loss. It's a rental activity, which is a business. Even though the TIC investors weren't involved in managing the property, there was a management company involved dealing with the upkeep of the property and the tenants.

If Option A is correct, there's no benefit to amending the 2015 return. The way the NOL calculation works is business capital losses are allowed only up to the amount of business capital gains (which there are none). So technically, you can never take a net operating loss based on business capital losses.

Option B: Report it on 8949 because it's an "investment" loss. This TIC endeavor is an investment. It's not a business. Even the SEC has found that TIC syndicates are "securities." This contradicts the general rule that rental sales are reported on 4797. Plus, I'm fairly certain the tenants of the office building were on triple net leases, which means they were more involved in the actual business of operating the building itself, rather than the TIC owners.

If Option B is correct, the trust beneficiaries would benefit from the capital loss carryover that would get distributed to them. Therefore, it would make sense to amend the 2015, 2016, 2017, and 2018 returns to report the foreclosure loss and carry forward the capital loss.

I can't find any direct information on this topic anywhere. If you knowledgeable fellow tax professionals might have any insight, or could point me in the right direction, I would greatly appreciate it.
 

#2
sjrcpa  
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Option A would give a 1231 loss and not a capital loss.
 

#3
ode923  
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sjrcpa wrote:Option A would give a 1231 loss and not a capital loss.


Thanks for the response sjr.

I used the term "business capital loss," because that's the term that the IRS uses on the NOL calculation worksheet.

See: Schedule A (page 3) of Form 1045, Line 11: https://www.irs.gov/pub/irs-pdf/f1045.pdf

Also: Publication 536 https://www.irs.gov/pub/irs-pdf/p536.pdf

Both of those sources distinguish "non-business capital losses" from "business" capital losses. Neither of those sources mention 1231 or 1250, but they refer to 4797 losses.
 

#4
Nilodop  
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Even the SEC has found that TIC syndicates are "securities.". The SEC regulates securities, and that's all that means. It's not a tax conclusion.
 


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