A "TIC"ING TIME BOMB: RULE 506 MEETS SECTION 1031

Fordham Journal of Corporate & Financial Law, 2007 by Whitman, Elizabeth Ayres

IV. TICs ARE GENERALLY SOLD UNDER THE EXEMPTION FROM REGISTRATION PROVIDED BY RULE 506 OF REGULATION D

A. Rule 506 Generally

Since TICs are securities, Section 5 of the 1933 Act requires that these securities be registered unless an exemption is available.52 Generally, TICs are sold through lower-tier securities broker-dealers under a safe harbor contained in Rule 506 of Regulation D,53 promulgated under the private placement exemption in section 4(2) of the 1933 Act.54 To qualify for the safe harbor under Rule 506, an offering must meet the following requirements:55

(1) There must be sales to no more than 35 non-accredited investors.56

(2) If an issuer sells securities to non-accredited investors, the investor must receive information that would be contained in a registration statement or offering circular, including certain audited financial statements.57

(3) There must be no general solicitation or general advertising in connection with the sale of the securities.58

(4) The securities may not be resold without registration unless there is an available exemption.59

TIC offerings are usually limited to accredited investors because sponsors are unable to meet the disclosure requirements required for sales to non-accredited investors. Although Rule 506 permits sales of a securities offering to up to 35 non-accredited investors, when a Rule 506 offering is made to non-accredited investors, there are enhanced reporting requirements in Rule 502(b).60 These requirements include the provision of audited financial statements to prospective investors.61 TIC offerings are usually sold pursuant to a private placement memorandum that largely follows the SEC's Industry Guide 5, and which provides most of the disclosure required by Rule 502(b). However, since TIC sponsors usually sell TIC offerings contemporaneously with acquisition of the real estate, the sponsors are dependent upon the sellers of the real estate for financial information about the real estate's prior performance. The financial information obtained from the sellers is usually unaudited, making it impossible for sponsors to provide the financial information required by Rule 502(b) if the offering is made to non-accredited investors. Therefore, sponsors have no choice but to limit sales of TIC offerings to accredited investors.

To qualify for the safe harbor in Rule 506, an offering made solely to accredited investors must meet the following two requirements: (1) there must be no general solicitation or general advertising in connection with the offering and sale of the securities;62 and (2) the securities may not be resold unless they are registered or subject to an exemption from registration.63

B. The General Solicitation and General Advertising Prohibition

Application of the prohibition on general solicitation and general advertising creates tensions with the timing requirements in section 1031. These requirements-particularly the one demanding that the taxpayer or investor identify replacement property within 45 days of the sale-frequently create an urgent need for a TIC investment if the investor is to successfully defer their otherwise substantial tax liability. The prohibition on general advertising and general solicitation, however, can make it difficult for sponsors and broker-dealers to gain access to investors, despite investors' clear need for a TIC investment.