1031 News This Week


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.


Simultaneous Closings Can Save You 1031 Exchange Fees

Rule #4 of my six basic rules for 1031 exchanges is you can not touch the money between the sale of your Old Property and the purchase of your New Property. IRS law requires that you use an independent third party (called a Qualified Intermediary) to handle your exchange. At least that’s the general rule. When you’re dealing with the IRS, there are usually exceptions to the rules, and such is the case with this rule. Being aware of this exception can save you the cost of an intermediary, which runs at least $500 in most parts of the country.


Narrow Deviation Allowed in 1031 title holding requirement

One of the critical requirements for a 1031 exchange is the same taxpayer must hold title to both the Old and New Properties in the exchange. While the exact amount of time these properties must be held is not defined by the IRS, it is clear that it has to be the same taxpayer, and both properties must be held for investment.

If Fred and Sue, for example, own an apartment building they are selling as joint tenants, and buy a replacement property for their exchange as joint tenants, then clearly the exchange involved the same taxpayers since Fred and Sue were on title for both the Old and New Properties. But what if Fred and Sue wish to protect themselves by putting the New Property into an LLC as soon as they acquire it? Most attorneys would say that was a smart business decision and quickly set up the LLC for them.

...if you have control over a transaction . . . the IRS could view your transaction as a violation...


1031 Exchanges Involving Your Personal Residence

1031 exchanges involve property you hold for investment, not your personal residence.  So why write an article about doing a 1031 exchange on your personal residence?  Everyone knows that your personal residence does not qualify for a 1031 exchange!  Or does it?

When you sell a residence you’ve lived in for two of the last five years, $500,000 of the gain is tax free if you’re married; ($250,000 if you are single).  This is your personal residence, which does not have anything to do with 1031 exchanges, right?  However it might.  You know the two-of-the-last-five-years rule, but did you ever ask yourself what the property was used for during the other three years?


Using 1031 Exchanges to Shift Gains Between Tax Years

As we start to wind down towards the end of the year, now is a good time to point out that 1031 exchanges are a great vehicle to use in shifting gain between two tax years. For example, if Fred and Sue sell their purple duplex on December 1, 2006, their 45-day identification deadline for their exchange is January 14, 2007. Section 1031 of the Internal Revenue Code requires that they send a list of potential acquisition properties to their intermediary no later than, in this example, this date. Failure to do so will terminate their exchange, causing the gain from the sale of their purple duplex to be taxable.


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