Tenancy in Common vs LLC for Real Estate (2026 Guide)

Co-owning real estate through an LLC is simpler in almost every respect except one, and that one matters enormously at the exit. An LLC interest is a partnership interest, and partnership interests are excluded from like-kind exchange treatment under IRC Sec. 1031(a)(2).

A tenancy in common interest is an interest in real property. It qualifies. When co-owners want to go separate ways at sale, one structure permits each of them to exchange independently and the other does not.

The Core Difference

A tenancy in common is direct co-ownership of real property. Each co-tenant holds an undivided fractional interest in the property itself, holds title, and may generally transfer, encumber, or exchange that interest independently.

An LLC is an entity. Members hold interests in the LLC, and the LLC holds the property. For tax purposes a multi-member LLC is a partnership by default, and its members hold partnership interests.

IRC Sec. 1031 permits exchanges of real property held for productive use or investment. Since the 2017 changes, personal property is excluded entirely, and IRC Sec. 1031(a)(2) has always excluded partnership interests.

The result is that a TIC co-owner can sell their fractional interest and exchange into replacement property individually, while an LLC member cannot exchange their membership interest at all. The LLC itself can exchange, but only if all members go the same direction.

Revenue Procedure 2002-22

The IRS will issue a ruling that a TIC arrangement is a co-ownership rather than a partnership if it satisfies the conditions in Revenue Procedure 2002-22. Those conditions are the working framework practitioners use even without seeking a ruling.

Key conditions include no more than 35 co-owners, title held directly by the co-owners as tenants in common, no business entity treatment or holding out as a partnership, unanimous approval required for sale, lease, refinancing, or hiring a manager, each co-owner having the right to transfer and encumber their interest, proceeds distributed proportionally, management agreements renewable annually, and no debt to a related party on non-arm's length terms.

The unanimity requirements are what make TICs operationally difficult. A single co-owner can block a sale, a refinance, or a lease. That is a real cost and it is the price of the tax treatment.

Why Most Co-Ownership Ends Up in an LLC Anyway

LLCs are simply easier. Majority or manager control replaces unanimity. Liability protection is stronger, since co-tenants can face joint liability. Lenders prefer a single borrower entity. Transfers are handled through the operating agreement rather than by recording deeds.

For co-owners who plan to sell the property together and take cash, or to exchange together into a single replacement property, an LLC costs nothing and is better in every operational respect.

The problem arises only when co-owners want different things at exit. One wants cash, one wants to exchange, one wants to buy the others out. An LLC makes each of those harder.

The Drop and Swap

The standard solution is to convert before the sale. The LLC distributes undivided TIC interests in the property to its members under IRC Sec. 731, generally without gain, and each former member then holds a direct real property interest that can be exchanged independently.

The risk is the holding requirement. IRC Sec. 1031 requires that property be held for productive use in a trade or business or for investment, both at the time of relinquishment and with respect to replacement property. A distribution executed days before closing invites an argument that the TIC interest was held for sale rather than for investment, and that the exchange was really a disguised partnership distribution.

The IRS has challenged drop and swaps, with mixed results. Courts have often sided with taxpayers where the facts were reasonable, but the risk scales with how close to closing the drop occurs.

The practical guidance is time. Execute the distribution as far ahead of the sale as circumstances permit, ideally in a prior tax year. Report consistently. Do not distribute after a purchase and sale agreement is signed if it can be avoided.

Form 1065 also asks directly whether the partnership distributed property in a like-kind exchange or contributed property to a partnership in a like-kind exchange. Answering this consistently matters.

The Swap and Drop Variant

The reverse structure, where the partnership completes the exchange and then distributes replacement property interests to members afterward, has the same holding period concern applied to replacement property.

It is generally viewed as somewhat safer, because the partnership itself performed the exchange and held the replacement property. But a distribution shortly after acquisition raises the same question in the other direction.

Where members know in advance they will separate, planning the structure years ahead avoids both problems entirely.

Tax Reporting Differences

A TIC arrangement does not file a partnership return. Each co-owner reports their proportionate share of income, deductions, and depreciation directly on Schedule E, based on their fractional interest.

Each co-owner has their own basis, makes their own depreciation elections, and may run a cost segregation study on their own interest. This independence is useful where co-owners have different tax situations, since one may want to accelerate depreciation while another does not.

An LLC files Form 1065, issues K-1s, and makes elections at the entity level. A cost segregation study benefits all members proportionally whether they want it or not, though special allocations under IRC Sec. 704(b) can create flexibility if drafted with substantial economic effect.

Worked Example: Three Investors, Divergent Plans

Three investors own a $4,600,000 retail property through an LLC, each holding a one-third interest. Adjusted basis is $2,100,000. They agree to sell.

Investor A wants cash to fund a business. Investor B wants to exchange into a single tenant net lease property. Investor C wants to exchange into two smaller residential properties.

Selling through the LLC forces one outcome. If the LLC exchanges, A cannot get cash without a taxable distribution. If the LLC sells for cash, B and C recognize their share of roughly $2,500,000 of gain.

Instead, fourteen months before listing, the LLC distributes undivided one-third TIC interests to each member under IRC Sec. 731. The distribution is non-taxable. Each investor holds a direct real property interest, reports on Schedule E, and files consistently for a full tax year before the sale.

At closing, A takes cash and recognizes roughly $833,000 of gain. B and C each engage a qualified intermediary and exchange independently into their chosen replacement property, deferring their gain entirely.

The fourteen-month lead time is what makes the structure defensible. The same transaction executed the week before closing would be considerably weaker.

Frequently Asked Questions

Can I 1031 exchange my LLC interest?

No. IRC Sec. 1031(a)(2) excludes partnership interests, and a multi-member LLC is a partnership by default. The LLC itself can exchange the property, but only if all members go the same direction. Individual members cannot exchange their interests.

What is a drop and swap?

Converting an LLC-held property into tenancy in common interests distributed to members under IRC Sec. 731 before a sale, so each former member can exchange independently. The distribution itself is generally non-taxable. The risk is the holding requirement, which is why timing matters.

How long before a sale should I do the drop?

As long as circumstances permit, ideally in a prior tax year. The IRS argument is that a TIC interest distributed days before closing was held for sale rather than for investment. Courts have often sided with taxpayers on reasonable facts, but risk scales with proximity to closing.

What are the requirements for a valid TIC arrangement?

Revenue Procedure 2002-22 sets the working framework: no more than 35 co-owners, direct title as tenants in common, no holding out as a partnership, unanimous approval for sale, lease, and refinancing, transferable interests, proportional proceeds, and annually renewable management agreements.

Which is better for co-owning rental property?

An LLC in nearly every operational respect: majority control instead of unanimity, better liability protection, and lender preference. TIC is better only where co-owners may want different exits, since it preserves each owner's independent 1031 ability.

Tenancy in Common vs LLC for Real Estate: The 1031 Exchange Difference