1031 News This Week


IRS Issues Vacation Home Ruling

The IRS has just issued a new ruling that sets forth the guidelines for those taxpayers that wish to do a 1031 exchange involving a vacation home. While I believe that the IRS intends that the ruling will put to bed all of the controversy surrounding this issue, it will certainly create more controversy than it settles.

By way of background, you can only exchange property held for investment or used in a trade or business. Personal use property, such as a residence, does not qualify for an exchange; so the question is: are vacation homes investment property or personal use property? Up until last year there was no guidance from the IRS that said that vacation homes do not qualify for an exchange, but that changed when the U.S. Tax Court disallowed a taxpayer’s exchange from one vacation home into another.


How I Handle My Vacation Home So That I Can Do A 1031 Exchange

After a recent Tax Court ruling that disallowed one taxpayer's 1031 exchange of his vacation (or "second") home, I've seen articles on this topic that range from "this was a bad ruling, so ignore it," to "the sky is falling and you can no longer 1031 vacation homes under any circumstance."

So can you exchange a vacation home? For those of you who are not familiar with this controversy, let me summarize the issue: Section 1031 allows the deferral of the gain from one investment property into another. Properties held strictly for personal enjoyment do not qualify. The question is, "Are vacation homes held for investment, or for personal enjoyment?” The Tax Court ruling clarified that vacation homes held strictly for personal enjoyment do not qualify. The trick then is to differentiate your property from purely personal enjoyment, and cast it, or document it, as investment property.


Security of Funds One of the Biggest Issues Facing 1031 Exchanges

Security is the big issue for those investors doing 1031 exchanges. There have been a lot of stories in the news lately about intermediaries who’ve taken their clients’ exchange funds. All of the bad things that happen with exchange accounts stem from commingled accounts, rather than separate exchange accounts. Yet few intermediaries place each exchange client’s money in a separate account for them; commingling is the industry standard.

When “commingling,” all of the exchange funds are placed in a single account rather than in a series of multiple, or “separate,” accounts set up for each client. The primary reason that intermediaries commingle is to maximize their personal return on your money – they earn a large return and pay you a small portion of it. With a separate account you get all the earnings from the account.


“Drop-and-swap” Problems with 1031 Exchanges

Structuring transfers of property for partnerships or limited liability companies without running afoul of the 1031 exchange rules can present problems. It's a common problem because you seldom can get all of the owners of a property to agree on the same course of action.

For example, Fred, George and Howie are equal partners in the FGH Partnership, which owns an office building they are under contract to sell. George and Howie want to sell the property, take their share of the proceeds and pay the tax. Fred, on the other hand, wants to do a 1031 exchange into a small apartment building he's found.


1031 Exchanges Targeted for more audits by IRS and states

Section 1031 of the Internal Revenue Code allows a taxpayer to roll the gain from the sale of their Old Property over to their New, provided they do certain things which are set out by the code. Most people seem to miss (or perhaps simply don’t understand) that Section 1031 is a “form driven” code section. This means you must do exactly what the code section requires. If you don’t, your exchange will be disallowed in an audit. In other words, you must dot the i’s and cross the t’s.


Beware more than ever about your exchange intermediary

At the beginning of the year, Southwest Exchange out of Henderson, Nevada, filed for bankruptcy after losing $100 million of their clients’ money. And this spring, local intermediary IXG and its sister companies in the 1031 Tax Group went down when they were unable to account for $150 million in client funds.

Most intermediaries put all of their exchange funds into one account, called a “commingled” or a “pooled” account. For years I’ve been writing articles, warning about the potential problems inherent in commingling 1031 exchange funds. And for years I’ve been the piñata of the exchange industry. I’ve been threatened with lawsuits and have been told by other intermediaries to: 'shut up and quit needlessly scaring the public about commingled accounts...!'


THE FUTURE of The 1031 Exchange Industry

So far in 2007, there have been three spectacular 1031 intermediary defalcations: Southwest Exchange of Henderson, Nevada ($100 million), Scoop Daniel of Breckenridge (the attorney that took one million and disappeared), and IXG (locally) and its related companies ($150 million).

All of these problems arise from two systemic problems with the industry: first of all there are no entry barriers to become an intermediary. Both Southwest and IXG were existing intermediary companies that were purchased by people who had no intermediary experience and whose sole intention for purchasing the company, apparently, was to get control of the exchange balance. Locally, Mile High Capital from last year is another example of this problem because according to several press reports they set up their own intermediary company and hired a convicted felon to run it.


Con Artist? or Good Guy in Trouble? Either way, the money’s gone

When I had my CPA practice, I used to tell people, 'you never get ripped off by someone you don't trust.' What I mean is, usually after a high profile fraud case, the victim often says something like, "I can't believe this happened," or "He seemed like such a nice guy." You never hear the victim say, "I'm not surprised. I knew he was going to rip me off..."

Likability is a good reason to do business with someone, but it's not a good reason to trust them. In a high profile case that has made national news, the secret fiscal life of Colorado Qualified Intermediary (or "QI"), Royal "Scoop" Daniel, III, is becoming more provocative as the details of his financial dealings are revealed.


TICs Sold in Colorado are Securities

Colorado Securities Commissioner, Fred Joseph has determined that TIC interests sold in the state of Colorado by Mile High Capital and Replacement Property Solutions are considered securities rather than real estate.  Replacement Property Solutions was the qualified intermediary arm of Mile High Capital, a real estate investment firm.  Both companies have been closed by the State and their principals indicted for securities fraud.

A TIC (Tenant-In-Common) interest is a small ownership slice of a large property.  In 2002 the IRS ruled that TIC interests qualify for 1031 exchanges.  This means an investor can sell a piece of investment property and buy a partial interest in a large property, such as an office building or an apartment complex.  Prior to the IRS ruling, there was confusion as to whether TICs were treated as real estate, or as partnership interests (which are not allowed as 1031 exchange replacement property).


IRS Challenges State's Definition of Real Estate in a 1031 Exchange

One of the basic concepts of a 1031 exchange is if something qualifies as “real estate” under state law, it qualifies as “real estate” for purposes of a 1031 exchange. For example, several years ago we were involved in an exchange of an oil and gas pipeline that crossed several states. Whether or not that pipeline was considered real estate depended on the laws of each state. As a result, we ended up with a situation where the portion of the pipeline in one state was classified as real estate, even though it was above ground, while another section of pipeline in another state was NOT considered real estate, even though it was buried in the ground.

In a recently released court case, the IRS challenged a state’s characterization of a property. This is the first time I’ve seen them do this, and it causes me some concern with how some types of exchanges are handled in Colorado.


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