FEATURE ARTICLE, OCTOBER 2005

WHAT DOES UTAH SENATE BILL 64 REALLY DO?
Utah's SB 64 creates confusion for people buying, selling and offering 1031 TIC properties.
Gary Beynon, Elizabeth Ayre Whitman and Daniel S. Rosefelt

Earlier this year, the Utah State Legislature adopted Senate Bill (SB) 64 modifying the Utah Uniform Securities Act to remove certain tenant-in-common (TIC) offerings from the definition of securities. This bill seems to be the result of the proliferation of the 1031 exchange TIC market, the uncertainty associated with proper licensing, and the general feeling amongst Utah real estate brokers that they are not involved in the sale of TIC interests in their state.

A TIC or undivided fractional interest in real property used in a trade or business or held for investment evidenced by deed can meet the 1031 exchange requirements, together with other requirements, as regulated by the IRS. The IRS has provided additional guidelines in Revenue Procedure 2002-22 for obtaining an advance private letter ruling for structuring TIC replacement property. There appears to be little confusion that TIC interests are real estate and treated as such for tax purposes even though they may be securities for securities law purposes. States have jurisdiction over the sale of real estate within their borders and most states generally require a licensed real estate broker be involved in the sale of that real estate. However, the rules and regulations vary from state to state.

When TICs are offered and sold together with certain other arrangements such as a management agreement or a master lease involving the program sponsor, they   do constitute “investment contracts” and thus are securities under both federal and most states securities laws. TIC interests are generally “investment contracts” because the tenants-in-common invest in undivided fractional interests in rental real property by pooling their assets and sharing in the risks and benefits of the enterprise, while obtaining profits derived predominantly from the efforts of the program sponsor (such as through contracts concerning leasing, management and operation of the acquired property).   The sale or offer of a security by means of any instrumentality of interstate commerce (eg. telephones, mail, internet, etc.), whether in one state or all 50 states, is subject to the federal securities laws.

The Securities Act of 1933 (the “Act”) requires any security offering must either be registered, or qualify for an exemption from registration. TIC offerings most commonly utilize the safe harbor provisions Rule 506 of Regulation D under the private placement exemption in the Act.

States may also have registration requirements for the sale of securities. However, under the National Securities Market Improvement Act (NSMIA) any private placement using the Rule 506 exemption is not subject to state registration. Most states, including Utah, have laws coordinating with Rule 506. Therefore, under NSMIA, the Utah legislature is pre-empted from imposing registration requirements on Rule 506 offerings. Accordingly, SB 64 did not modify the Utah Uniform Securities Act acknowledging the NSMIA pre-emption. Likewise, under NSMIA any rules adopted by the Utah Real Estate Commission under SB 64 cannot apply to TICs sold pursuant to a Regulation Rule 506 exemption.

So what's the impact from SB 64 on Utah real estate? It seems to be confusion and paralysis for the professionals involved with buying, selling and offering 1031 TIC properties. Sponsors of security TIC properties are stopping at the borders of Utah, hesitant to purchase Utah commercial properties, when they sense that their established channels of licensed securities representatives nationwide may not sell Utah TICs. These security representatives are concerned with the consequences from selling real estate without a license due to the attention spotlighted by SB 64. The TIC sponsors and sales representatives are turning elsewhere to conduct TIC business. Utah real estate brokers should be hesitant to sell TICs because, notwithstanding SB 64, federal securities laws require that persons selling TIC securities (for federal law purposes) be federally registered broker dealers (or associated persons) or exempt from registration. A determination that a particular transaction does not involve a security for purpose of state law is not determinative and is irrelevant for purposes of federal securities law.  

In a very narrow instance, a Utah TIC offering can be exempt from federal registration under the intrastate exemption safe harbor found in Rule 147 adopted under the Act, which requires both the sponsor to be a resident of and doing business in the state that the purchasers and offerees all be residents of that state, and that the proceeds from the offering primarily be utilized in that state. Simply put, Rule 147 is of use with SB 64 only for Utah sponsors who sell TIC interests in Utah real estate solely to Utah residents. For purposes of Rule 147, if a sponsor is to be considered a resident of Utah, it must have derived 80 percent of its gross revenues on a consolidated basis from inside Utah. Therefore, it is unlikely that a sponsor offering TICs in other states will qualify for the intrastate exemption.

In conclusion, SB 64 is of little practical use for sponsorship of TIC programs, which generally constitute investment contracts (“securities”) under federal law. Furthermore, even if every state legislature in the nation enacted a similar law, it would still make no difference due to the preemption under NSMIA and the narrow federal exemption under Rule 147.

Gary Beynon is founder and CEO of Omni Brokerage Inc., Elizabeth Ayre Whitman is an attorney with Rosefelt Law Firm and Daniel S. Rosefelt is an attorney and CPA with Rosefelt Law Firm.


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