TIC Compliance: Rev. Proc. 2002-22 Rules and 1031 Exchanges

For a tenants-in-common arrangement to be respected by the IRS as direct co-ownership of real estate rather than a disguised partnership, it has to satisfy the safe harbor conditions in Revenue Procedure 2002-22. Those conditions govern how many co-owners the arrangement can have, how decisions are made, how income and expenses are split, what each owner can do with their share, and how leases and management contracts are written. Miss the mark, and the tax treatment that makes TIC investing attractive — direct real property ownership eligible for a Section 1031 exchange — can collapse.

What Revenue Procedure 2002-22 Is

Revenue Procedure 2002-22 is a safe harbor for obtaining a private letter ruling from the IRS. It lists the conditions the IRS wants to see before it will confirm that a TIC arrangement qualifies as co-owned real property rather than a partnership or other business entity. The procedure itself states these guidelines are “not intended to be substantive rules” for audit purposes.¹

That distinction matters. A TIC arrangement that falls outside one of the safe harbor conditions is not automatically reclassified as a partnership, and the IRS says it “may consider a request for a ruling” when the conditions aren’t fully met, as long as the facts clearly support the arrangement.¹ In practice, though, nearly every TIC sponsor structures the deal to hit every condition. Straying from the safe harbor invites scrutiny and creates risk most investors won’t accept.

The 35-Person Cap on Co-Owners

The total number of co-owners in a TIC arrangement cannot exceed 35 persons.¹ The cap draws a line between genuine co-ownership and large-scale syndications that resemble investment funds.

Two counting rules compress groups into a single “person.” A married couple that acquires their interest together counts as one. People who inherit a co-owner’s interest after that person’s death also count collectively as one person, no matter how many heirs are involved. Otherwise, each individual investor or entity holding a fractional share is counted separately toward the 35-person limit.

Unanimous Consent for Major Decisions

One of the clearest lines between co-ownership and a partnership is how decisions get made. In a partnership, managers or a majority act for everyone. In a compliant TIC, the big decisions stay with the full group. Revenue Procedure 2002-22 requires unanimous approval of all co-owners for:¹

Selling or otherwise disposing of the property. No subset of co-owners can force a sale.
Leasing or re-leasing any portion of the property. Every new lease and every renewal needs everyone’s sign-off.
Creating or modifying a blanket lien. Any mortgage or trust deed recorded against the entire property, and any renegotiation of that debt, requires full agreement.
Hiring a property manager. Both the choice of manager and the terms of the management contract require unanimous approval.

Routine operational decisions outside those categories can be handled by majority vote. But the unanimity requirement for the big-ticket items is non-negotiable within the safe harbor. It’s what most clearly demonstrates that each owner keeps genuine control over their investment.

Proportional Sharing of Income and Expenses

All income, expenses, and liabilities tied to the property must be allocated in exact proportion to each co-owner’s percentage interest.¹ Own 15 percent of the property, and you receive 15 percent of the rental income and bear 15 percent of every cost, from property taxes to maintenance bills.

The IRS specifically prohibits “special allocations,” a hallmark of partnership tax planning. In a partnership, partners might route a disproportionate share of depreciation to one partner who needs the tax offset. That flexibility is exactly what makes a partnership a partnership in the IRS’s eyes. In a compliant TIC, every dollar follows the ownership percentages on the deed.

Transfer, Partition, and Encumbrance Rights

Each co-owner must keep the independent right to transfer, partition, or encumber their undivided interest without needing anyone else’s permission.¹ That’s a fundamental feature of co-ownership: you can sell your share, pledge it as collateral, or force a physical division of the property on your own. If group approval is required for any of those things, the arrangement starts to look like a business entity.

Two narrow exceptions soften the rule. A lender can impose transfer restrictions consistent with normal commercial lending practices. And the other co-owners, the sponsor, or the tenant may hold a right of first offer, meaning they get the first chance to make a purchase offer before the selling co-owner goes to outside buyers. A co-owner can also agree to offer their interest to the group at fair market value before exercising a partition right. These carve-outs let the group maintain some stability without crossing into partnership territory.

Call Options Allowed, Put Options Prohibited

Revenue Procedure 2002-22 draws a sharp distinction between the two. A co-owner may grant a call option allowing someone else to purchase their interest, but the exercise price must reflect the fair market value of the property at the time the option is actually exercised, not a price locked in earlier.¹

Put options are flatly prohibited. A co-owner cannot acquire the right to force the sponsor, another co-owner, the tenant, the lender, or anyone related to those parties to buy their interest.¹ The logic is straightforward. A put option would function like a guaranteed exit, which is something you get from a business arrangement, not from owning a piece of land. The fair-market-value requirement on call options serves the same purpose: a fixed-price buyback set years in advance would look more like a redemption right in a partnership than a true property transaction.

Management Agreement Rules

Hiring a property manager is standard in TIC arrangements, especially for commercial properties where day-to-day oversight is impractical for a scattered group of investors. But the management relationship has to stay in the lane of a service contract rather than drifting toward a business partnership.

The management agreement must be renewable no less frequently than annually, giving co-owners a regular chance to evaluate the relationship and replace the manager. The manager’s compensation cannot depend in whole or in part on the income or profits derived from the property, and fees must not exceed fair market value for the services provided.¹ A flat fee or a percentage of gross rents is typical. A cut of net profits crosses the line because it gives the manager a financial stake that looks like an ownership interest.

Co-owners must also keep the ability to terminate the manager on reasonable notice. Annual renewals, fair-value compensation, and termination rights together keep the manager in a vendor role rather than a partner role.

Lease and Rent Requirements

Every lease on a TIC property must be a genuine lease at fair market rent. Revenue Procedure 2002-22 prohibits rent that depends on the net income, cash flow, or equity growth of the property.¹ Rent can be based on a fixed percentage of gross receipts or sales, which is common in commercial retail leases. The distinction mirrors the REIT rules under Section 856(d)(2)(A), and the principle is the same: tying rent to the tenant’s profitability makes the landlord look more like a business partner than a property owner.

When multiple parcels are leased to a single tenant under one master lease and secured by common debt, the IRS generally treats all the parcels as one property. Each co-owner’s percentage interest must then be identical across every parcel, and those interests cannot be separated or traded independently.

Why Compliance Matters for a 1031 Exchange

The reason these rules matter to most investors is Section 1031. Under 26 U.S.C. § 1031, you can defer capital gains tax when you sell investment real property and reinvest the proceeds in like-kind replacement property.² A TIC interest in compliant real estate qualifies as a direct real property interest for this purpose, which means you can exchange into or out of it and defer the tax. A partnership interest does not qualify. That single distinction is why the compliance conditions above exist, and why sponsors, investors, and their advisors pay such close attention to them.

TIC interests are especially useful as replacement property because they let an investor place exchange proceeds into a large commercial asset without needing to buy the whole building. Someone selling a $500,000 rental can acquire a fractional interest in a $15 million office building and still complete a valid exchange, as long as the TIC arrangement satisfies Rev. Proc. 2002-22.

What Happens if the IRS Reclassifies Your TIC as a Partnership

If the arrangement fails the safe harbor conditions and the IRS determines the co-owners are actually operating as a partnership, the consequences run in several directions. The group would need to file a partnership return on Form 1065 and issue Schedule K-1s to each co-owner. Individual owners would lose the ability to claim depreciation, mortgage interest, and other deductions directly on Schedule E, receiving passthrough items from the partnership instead.

The most damaging consequence for investors who entered through a 1031 exchange is that partnership interests do not qualify as like-kind real property under Section 1031.² A reclassification could retroactively disqualify the exchange, triggering the deferred capital gains tax plus interest and potential penalties. For investors who deferred six- or seven-figure gains, that’s the scenario tax advisors worry about most.

Co-owners who want an additional layer of protection can elect under 26 U.S.C. § 761(a) to be excluded from partnership treatment, provided the arrangement is used for investment purposes only and not for active business operations.³ The election requires agreement from all members of the group and applies only when each member’s income can be adequately determined without computing partnership taxable income. It’s a belt-and-suspenders measure, but it adds meaningful protection when the facts are favorable.

1
Internal Revenue Service. Rev. Proc. 2002-22
2
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
3
Office of the Law Revision Counsel. 26 USC 761 – Terms Defined