Year-end Tax Planning with Section 1031

If you are selling property before the end of the calendar year, you have a potential opportunity to plan for taxes in 2010 by utilizing Internal Revenue Code section 1031 as a tool. Whether a 1031 exchange is ultimately completed or not, there may be an opportunity to choose whether the tax will be paid in 2009 or 2010. This is because, under exchange rules, your right to receive the proceeds from the sale of the property are held by a third party Qualified Intermediary. If you are unable to identify or close on a sale, and subsequently, the exchange fails, your first right to the proceeds doesn't occur until 2010. How is that? It has to do with the time of year we have entered.

Under 1031 exchange rules, a person exchanging property may receive the sale proceeds (a) after the expiration of the 45 day identification period (if the taxpayer did not identify any replacement property); or, (b) the date upon which the taxpayer acquires all replacement property identified by the taxpayer in the exchange, or (c) at the end of the 180 day exchange period. So if you sell a property on December 15th, your 45 day period would not occur until January 29th.

Section 1031 says that if your exchange fails in a different tax year than the year you sold it, the IRS's installment sale rules kick in. So, the taxes that would be due in 2009 could be deferred until 2010. I say COULD be because the installment sale rules also allow you to elect out of them.

If the Obama administration and Congress decide to raise capital gains rates before the Bush tax cut is set to expire at the end of 2010, a taxpayer whose exchange failed could elect out of the installment reporting rules. This also might help if you determine, before filing your tax return, that it would be better to go ahead and recognize the gain in 2009. This stategy, setting up an exchange now, would allow you to plan and recognize the gain in the year of greater tax benefit for you.

Of course, you should have a legitimate intent to complete an exchange and not simply look at this as a tax deferral strategy. However, if you are selling real estate and MIGHT reinvest the proceeds in replacement property, it could certainly make sense to setting up an exchange - just in case. If you are considering this option, you should also consult with your tax accountant or attorney regarding your specific tax situation. For more information on this option, visit our 1031 exchange professionals website or give us a call at 888-367-1031.

Swap and Drop Exchange Upheld by Oregon

As we've previously indicated, there are situations where a partnership may split up or liquidate but one or more partners may want to defer capital gains through the benefits of a 1031 exchange. Perhaps the partners have different goals or they simply no longer want to stay in business together. Partners often want to go in different directions with their share of the proceeds. Some may want to reinvest in real estate and can defer their taxable gain through use of a 1031 Drop and Swap.

The opposite can also happen where an investor exchanges a property and wants to enter into partnership with other investors. This is known as a "Swap and Drop". This investment would take the form of a tenancy-in-common interest in the property. It has been previously thought by many tax professionals that this undivided fractional real estate interest should be maintained for a sufficient period of time in order to satisfy the 1031 "held for investment purposes" requirement.

However, a recent court case in Oregon puts some doubt into whether this is really necessary. In the case of the Oregon Department of Revenue v. Marks taxpayers had acquired a tenancy-in-common interest as replacement property for their exchange. They then immediately contributed the replacement property to a partnership (a "swap and drop"). The Oregon Department of Revenue (affectionately referred to hereafter as ODOR) challenged the exchange based on the partnership "drop". The original court ruled that the taxpayers had indeed met the guidelines of a 1031 exchange and it was permissible to exchange and then immediately contribute the property to a partnership. ODOR appealed that decision but the Tax Court upheld the original ruling.

Within the appeal ruling the Tax Court referenced the 9th Circuit court case of Magneson v. Commissioner. In that case, the 9th Circuit held that the transfer did not impair investment intent and that the transfer to the partnership changed the form of ownwership but not the substance of real property ownership. The Tax Court determined that the taxpayers' continuity of interest and lack of cashing out override the ODOR's concerns about the short holding period of the replacement property.

This is significant in that Magneson preceded adoption of a subsection of IRC 1031 ((a)(2)(D))that excludes partnership interests from property that can be exchanged. It appears from the reference that the court continues to affirm the view that the partnership is an aggregate of its partners (in contrast with a corporate entity status being seaparate from its shareholders.

It should also be highlighted that the Oregon court case only applies to Oregon STATE tax and not to Federal tax. The assertive Franchise Tax Board in the state of California is reportedly pursuing a case contesting the "Swap and Drop" tax strategy. It appears that case involves similar arguments that the immediate transfer demostrates the taxpayer lacked investment intent at the time of acquisition.

Neither the statute, the Revenue Code, the IRS, nor the courts have provided complete certainty in this area. The 2008 Partnership Tax Form 1065 was revised to include questions regarding "Drop and Swaps" and "Swap and Drops". This change was made to "enable the IRS to focus compliance resources on returns and issues that warrant examination. What, if any, resources is unclear. But it does appears that the IRS has some interest in continuing to fight court cases involving "Drop and Swaps" and "Swap and Drops". If you are contemplating such an exchange, you should consult with your tax professional(s) and speak to your 1031 exchange professional early in the sale process to attempt to understand and mitigate your financial risk. Of course, if you have any questions about 1031 exchanges, you can give us a call free of charge at 888-367-1031.

1031 Regulation Part of CFPA Bill

Representative Michael Michaud (D-ME2) successfully added an amendment to the the "Wall Street Reform and Consumer Protection Act of 2009". HR 4173 would establish the Consumer Financial Protection Agency as the primary regulatory body over 1031 Exchange Qualified Intermediaries.

The CFPA bill was quickly introduced on December 8th and passed the House late last Friday by a vote of 223 to 202. It now moves to the Senate. If passed there and signed into law, the bill would usher in, what CNN describes as, “the most sweeping set of changes to the banking regulatory system since the New Deal.”

Michaud's amendment requires that the Director of the CFPA conduct a review of Federal laws and regulations relating to the protection of individuals that utilize exchange facilitators , submit to Congress recommendations on the steps necessary to ensure appropriate protection of such persons and establish and carry out a program, utilizing the authority of the CFPA, to protect individuals that utilize exchange facilitators.

Calls for reform, in light of the previously covered Okun 1031 Tax Group and LandAmerica Exchange fraud and failure, have come from consumers as well as many within the QI industry. A few states, including Colorado, have established their right to regulate 1031 exchanges within their borders. However, the federal bill and the Michaud amendment makes no mention of what protections should be established. Instead it puts the power to decide solely in the hands of the CFPA Director.

Some in the QI industry, that appear to have pushed for the bill amendment without industry association support, have suggested regulatory requirements that Qualified Intermediaries have specific prohibitions against illiquid investment vehicles and require the exchange facilitator to hold funds in a segregated bank account. They have also called for audits of Qualified Intermediaries.

While not in disagreement with these sound financial business principles, the wild card in any government intervention into the financial markets is what the CFPA Director decides to recommend. Many within the financial industry are concerned the legislation creates sweeping new powers for the federal government and may have unintended consequences that reduce access to credit and financial services while increasing the costs. One thing seems logical...such a "superagency" regulator, would further increase costs of running the federal government and increase costs to those within the financial industry - costs that will undoubtedly get passed on to consumers.

First Signs of Life for CMBS Reincarnation

Two successive commercial mortgage bond offerings have many hopeful that the CMBS market may be showing signs of recovery while others question just how quickly this initial sign of life may jump start a dead market.

In late November, a real estate investment trust (REIT), Developers Diversified Realty Corp., broke the market with the assistance of the Federal Reserve's Term Asset-backed Securities Loan Facility (TALF). The $400 million deal was met with strong investor demand as evidenced by the significant subscription activity and the resulting Treasury price premium reduction. The offering was the first true CMBS transaction to reach the market since June 2008.

As further evidence that the CMBS market may be showing early signs of life, Bank of America followed by pricing a $460 million offering for Flagler Development (backed by Fortress Investment). That issue was secured by office buildings and industrial investment property in Florida and was brought to market without any TALF support. A third offering, a $500 million retail investment property deal for Inland Western Retail Real Estate Trust Inc., is scheduled to come to market from JP Morgan. It, too, is said to be free of any TALF backing.

Goldman Sachs, Bank of America and JP Morgan have all publicly announced that their door is now, or will shortly be, open for new securitization activity. Reports indicate that Deutsche Bank and Royal Bank of Scotland are also firing up their conduit lending programs. So far, the deals announced have been limited to single-borrower transactions that were reportedly "conservatively underwritten and well-structured". Many industry experts have commented that they believe this niche may spark a welcome revival to thawing the lifeless private-label CMBS market.

Most would agree that this is a welcome sign. The deals brought to the market thus far seem to have transparency, low leverage and, thus, have been positively acknowledged. Only time will tell whether these initial CMBS offerings will return the market to pre-2008 levels of credit availability for commercial real estate. Of course, the wild card may turn out to be how open Congress will allow the markets to be.

But, if investors continue to respond positively to these low-leverage deals, it should prove to be something of a positive catalyst for the commercial real estate sector and may stem the tsunami of billions of maturing securitization dollars that are scheduled to mature in the next couple years. Just how distressed the commercial market gets remains to be seen. Much of that will depend on the state of the economy and the substantive, yet sensible, reincarnation of the capital markets.

Section 1245 Property Issues in 1031 Exchange

Many taxpayers don’t immediately recognize that the sale of Section 1245 property is subject to depreciation recapture at ordinary income tax rates. This can be a startling discover when their tax bill is calculated. Section 1245 property is subject to tax at ordinary rates to the extent of any gain on the sale and to the extent depreciation is recognized on the property since acquisition.

Section 1245 Property is generally depreciable personal property whether tangible (such as machinery, equipment, furniture and fixtures) or intangible (such as patents, copyrights, and subscription lists). However, real property can sometimes include Section 1245 Property subject to the same depreciation recapture rules. Some examples of real property which is also Section 1245 Property include –

• Cost segregated real property that includes components which are depreciated as personal property.
• Oil and gas storage tanks, grain storage bins, silos.
• Certain commercial real estate acquired between 1981 and 1986 which was depreciated using an accelerated method.

Section 1245 property that is a part of the sale of real estate, attributable to the realized gain and depreciation taken on Section 1245 property, will be taxed at ordinary income tax rates instead of the preferred capital gains tax rates (subject to previously non-recaptured section 1231 losses).

In a 1031 exchange of real estate, realized gains are deferred if qualifying replacement property is acquired and if there is no taxable “boot” received. However, if the real estate exchanged contained any Section 1245 Property, there will be a Section 1245 depreciation recapture unless the replacement real estate also includes Section 1245 Property of equal or greater value. Any “trade-down” in the Section 1245 Property will result in Section 1245 depreciation recapture taxed at ordinary income tax rates.

Taxpayers with Section 1245 property embedded in their real property should consult with their qualified legal and tax professionals on the potential recapture occurring when contemplating either a sale or exchange. If you’ve questions on the 1031 exchange of Section 1245 property, 1031 Corporation would be happy to consult with you and your tax professional. Give us a call at 888-367-1031.

Guaranteed Returns, Commingled Funds & Related Company Transactions

In 2002, an Internal Revenue Service ruling (Procedure 2002-22) set forth guidelines for purposes of determining where undivided fractional ownership interests in real estate could be treated as ownership of real estate. Under the ruling, if "essential elements" of the TIC arrangement are followed, TICs qualify for 1031 exchange deferral of taxes. The structure of a TIC can be beneficial to many investors tired of active daily real estate management. There are many solid TIC sponsors in the market today. However, this is the story of one that wasn't.

By 2005, TICs were a hot commodity. At one time, Boise, ID-based DBSI, which operated under names such as Spectrus Real Estate and For 1031 LLC, was riding near the top of the heap. The 29 year old company became one of the nation's biggest sponsors of Tenant In Common (TIC) ownership interests in commercial properties across the United States. By providing smaller investors with access to the institutional properties markets and, in some cases, a guarantee of investment returns (from 6.5% to 12% returns annually -- whether or not the property performed well), DBSI became one of the most well-known TIC sponsors in a rapidly growing industry. Guaranteed returns, regardless of performance....really?

But as the commercial market began slowing in 2007 and 2008, DBSI began reporting problems. By September 2008, the house of cards quickly began to crumble. In a letter to investors, DBSI indicated it was "temporarily" reducing or eliminating payments. Within six weeks, DBSI had declared Chapter 11 bankruptcy. With the bankruptcy, day-to-day management of its properties broke down.

In October 2008, bankruptcy court-appointed examiner Joshua R. Hochberg, former chief of the Justice Department's fraud section, began investigating claims of fraud. He was directed to investigate allegations that DBSI defrauded investors out of $500 million. DBSI founder and president Douglas Swenson was alleged to have taken somewhere in the neighborhood of $160 million ( (Swenson's counsel denies he did anything wrong).

Hochberg’s (preliminary report, released in June, indicates a tangled web of closely related companies primarily controlled by Swenson. Transactions within the company - including transfers among DBSI related companies, Swenson, and four other minority owners - were more numerous that previously believed. Instead of investing the money as promised, Hochberg declared that the company was "an elaborate shell game." Hotchberg's report seems to indicate that as the market cratered, and new cash infusions dramatically slowed, DBSI and its affiliates used new investor proceeds to continue their daily operations and pay off existing debts. His report also claims that Swenson, DBSI and several other executives exerted control over dozens of DBSI affiliates and essentially ran them as a unified business with commingled funds (where have we also heard this other major problem before?).

Hotchberg continues to investigate the demise of DBSI. A more complete, final report should be out soon. What will the report conclude? Based on the the initial report indicating commingled funds, closely-related transactions and guarantees of returns - three major flags in previous schemes - I'd say it, unfortunately doesn't look good for investors.

LandAmerica and Okun

The Federation of Exchange Accommodators released their November newsletter recently updating member firms about the legal proceedings in the Ed Okun and LandAmerica Exchange cases.

The Okun case sentencings have now been completed for the wrongs committed in the failure of 1031 Tax Group. The last of three former employees, the chief legal officer of Okun's organization, was sentenced to three years in prison. Along with the 100 year prison term Okun was sentenced to earlier, the chief operating officer was sentenced to 10 years and to five years.

In the LandAmerica case, it appears there is a possible settlement pending on the bankruptcy proceedings. Customers who set money with LandAmerica but did not specify exactly how it was to be held will get $0.25 on the dollar from the former Qualified Intermediary arm of LandAm Title. Customers who put funds in segregated accounts will get will get $0.70 on each dollar they set aside, and customers who specified their funds be put in escrow will get $0.97 on each dollar they put with LandAmerica. In this case the court took a very stringent view of tracing and heavily weighed the argument that the funds were not co-mingled. Seggregated accounts is something we've always strongly advocated (and always followed in our practice).

With the approaching holiday, we at 1031 Corporation want to wish you all a Happy Thanksgiving. We know this year hasn't been an easy one for many of us but we certainly realize there is still much for which to be thankful. We hope your travels will be safe and that you'll enjoy time invested (I always hated the idea that we SPEND time) with family and friends.

Arizona 1031 Fraud Conviction

Late Friday, a Phoenix television station reported news that a Litchfield Park married couple that had claimed to be a Qualified Intermediary was convicted of fraud. The couple did business under the name 1031 Exchange Consultants, LLC (as well as Etna Land Trust; Executive Realty Group; and Tax Management Consultants, LLC).

Owner of 1031 Exchange Consultants, Gordon Deibler, acted as a Qualified Intermediary (QI) through the companies and accepted the proceeds from property sales for clients. Instead of securely holding the funds and then using the proceeds to purchase replacement property for his clients, he diverted the money for personal use.

The couple was also involved in a mortgage loan scheme with their handyman where they inflated the property value and falsified credit and income information for a loan application.

According to news reports, Mr. Deibler pleaded guilty to one count of directing a criminal syndicate and one count of fraudulent schemes and artifices. He faces a prison term of somewhere between three and twelve years and was ordered to pay restitution to the victims in the amount of $1.6 million.

Once again we have a story hitting the news of another fraudulent individual acting as a Qualified Intermediary. While regulation may slow some of these schemers down, criminals will still find ways to break any laws written. This couple is a perfect example of that. I don't think it would have mattered what laws were written. They clearly had no conscience about stealing money from individuals that placed their trust in them.

We've written of the need to fully investigate the Qualified Intermediary you use. Much like you would want to know the bank you place your money, the investment advisor you use, the accountant or attorney you retain, you should review the qualifications, experience and safety of your Qualified Intermediary. 1031 Corporation is a subsidiary of FirstBank. While a bank-owned QI is not the only choice, investment requirements of banks are highly regulated. Further, a typical bank-owned Qualified Intermediary will segregate funds, have a high amount of bonding and financial backing as well as have dual control procedures in place to ensure checks and balances are maintained.

You have a choice when selecting a Qualified Intermediary. You should use that choice to make sure you are comfortable knowing who is assisting you in your 1031 exchange needs. Give us a call at 888-367-1031 if we can assist you with questions or setting up your 1031 exchange today.

1031 Corporation Parent Reports Strong 3rd Quarter

As reported yesterday in the Northern Colorado Business Report, - FirstBank Holding Company - the Lakewood-based holding company for the largest locally-owned banking organization in Colorado - reported increases in all its key financial measures for the nine months ending Sept. 30, 2009. Net income grew was up 15 percent to $109.88 million compared to the same period in 2008. The company's earnings increased by 17 percent from the comparable period a year ago.

Total assets were $9.84 billion and total deposits increased to $8.95 billion, up 6 percent and 13 percent respectively. Total loans grew 9 percent to $4.22 billion, and return on average shareholder equity was 22.1%.

"FirstBank has performed exceptionally well in 2009, and our third-quarter financial results show that we've been able to sustain the momentum we created during the first half of 2009," said John A. Ikard, president and CEO of FirstBank Holding Co. "Concentrating on our core business has allowed us to better serve our customers and deliver value to our shareholders."

Ikard noted that FirstBank does not originate, hold or purchase any subprime mortgage loans or securities, a fact that has helped the company avoid costly credit losses.

FirstBank also expanded its geographic footprint during the third quarter of 2009 by opening a new branch location in Surprise, Ariz. It operates 121 locations in Colorado, eight in Arizona and five in California, serving more than 600,000 customers.

1031 Corporation, a subsidiary of FirstBank offers nationwide Qualified Intermediary services and strategy consultation for tax-deferred, like-kind exchanges.

All-Cash TIC Advantage for 1031 investments

Some time back, I saw an interesting article by Robert Johnson - president of St. Paul-based AEI Capital Corporation - discussing the advantages of an all-cash tenant-in-common investment. I asked, and received, his permission to re-publish some of the important issues he describes in the article. The full article appeared in the January 2009 National Real Estate Investor. The article contains solid information for 1031 investors that lack debt in their relinquished property and are looking for suitable replacement property investments.

Access to affordable capital has rapidly become a difference maker in the tenant-in-common industry. TIC sponsors that able to use an all-cash acquisition and offering strategy are getting a leg up on their leverage-dependent competition. Moreover, a lack of acceptable financing is forcing some leveraged TIC sponsors to delay bringing. or to pull altogther, deals to the market.

Sales volume in the Tenant-In-Common industry has been reduced due to a decline in U.S. real estate sales and the corresponding decrease in demand for 1031 exchange properties which enable investors to defer capital gains taxes. Despite the drop in sales volume, the TIC property ownership structure remains sound for suitable 1031 exchange buyers.

Benefits of an all-cash TIC transaction include no foreclosure risk, no interest rate refinance risk, and less risk of capital calls. Added benefits include avoiding the bank application process, easier resale, and flexible 1031 exchange closing schedules.

All-cash TIC properties usually generate a slightly lower rate of return. On the other hand, the front-end fees associated with all-cash transactions will normally be less than those of TICs using debt. Ultimately, the all-cash model provides an added layer of protection that is attractive in a market where investors are increasingly averse to risk.

Although TIC offerings requiring leverage are still offered, they are considerably more difficult to organize in today's relatively illiquid market. As financing has become more expensive, and difficult to obtain, the advantages of an all-cash strategy become more meaningful for 1031 investors.

As Mr. Johnson points out, all-cash TIC offerings tend to focus on properties priced under $10 million and may not be suitable for all 1031 exchange investors looking to reduce risk (larger, institutional-grade properties are typically perceived by investment professionals to contain less overall risk). TIC offerings should be reviewed with full due diligence and a complete understanding of the investment risks. If you are considering an investment in a tenant-in-common property, you should discuss the offering details with your legal and tax professionals. For futher details on the ideas expressed here, contact Robert Johnson at 800-328-3519 or at aei1031@aeifunds.com.

Reality of Lending

Our economy is struggling. We all know that. But understanding why, what happened, and how the banking industry and the government is responding can be complicated and timely. The Colorado Bankers Association recently released information about the "lack of lending” in order to encourage the appropriate coverage of the issues surrounding this frustrating topic.

They have released a brochure titled, The Reality of Lending that details what they believe to be reasons for the current "credit crunch". Below is some of the highlights of the facts they are hoping are addressed.

Banking takes appropriate responsibility for its prudent loan standards. We also think customers and the public deserve to understand other factors that significantly impact the ability to get credit in this environment.

The lack of lending (heavily criticized by the public, media, and public officials) reflects low loan demand and is attributable to borrower creditworthiness issues, lender financial constraints, and regulators’ tougher standards, and is exacerbated by the greatly diminished role of nonbank lenders recently. For business borrowers who are key to an economic recovery and already have financial strain this means banks are their primary source of credit and banks are unable to make many of the loans for the reasons stated. This is especially difficult for loans secured by real estate.

Changing regulatory standards in capital requirements, loan concentrations, and loan downgrades often result from subjective judgments and national benchmarks. They disallow recovery of real estate values over time, and often prompt shrinkage of the bank which reduces lending and greatly impacts customers.

Bank lending plays a critical role in our economic recovery. Borrowers and lenders are addressing financial constraints and are working through issues. Bank regulation and examination are essential to a sound banking system. CBA recognizes this essential role but also believes regulators are impairing bank lending and thus the recovery by overly aggressive actions in capital standards, concentration standards, and loan downgrades. CBA is providing essential information to bankers, public officials, the public, and major customer groups.

The site titled Financial Information for Consumers has additional information on this and other topics such as Home Mortgages, Identity Theft, Credit Awareness and Loans.

Related party basis shifting case upheld

A Ninth Circuit Court of Appeals decision to affirm a previous Tax Court ruling further highlights the need for extra scrutiny in 1031 exchanges involving related parties. The 2005 Tax Court decision, involving exchanges of condominium and apartment properties (Teruya Brothers), disallowed the tax deferred swap because it occurred between related parties and the main reason for the exchanges was to reduce the overall tax bills of the buyer and seller.

In the case, the entity (Teruya Bros, Ltd) that owned the apartment building and condominium complex had a built in, large capital gain. Upon the sale, a $13 million capital gain would have resulted to this entity triggering a massive tax bill. Rather than sell, the entity transferred the real estate to an unrelated Qualified Intermediary (QI) which sold the properties and bought replacement land from a subsidiary (Times) in which the entity had a controlling interest.

The issue that causes this related party exchange to be disallowed essentially relates to the overall tax paid. The subsidiary did not exchange into additional replacement property. Rather, it chose to treat the sales as taxable events and accounted for a capital gain of roughly $3.5 M on the property sale to the related entity. However, the subsidiary that sold the property had significant net operating losses from previous operations. These NOLs were used to offset the $3.5 million gain - resulting in no taxes paid on the sales.

Effectively, what the related party exchange attempted was a "cash out". The subsidiary now had the cash from the sales. The two related entities combined had decreased their investment in real property by approximately $13.4 million while increasing their cash position by the same amount. By disallowing the related parties to cash out of a significant investment in real property under the appearance of a 1031 like kind exchange, the Appeals Court upheld the previous Tax Court decision that "these transactions were undoubtedly structured in contravention...that nonrecognition treatment only apply to transactions "where a taxpayer can be viewed as merely continuing his investment.""

It is clear that tax deferred exchanges between related parties are subject to additional scrutiny. Accounting professionals, tax and real estate attorneys and taxpayers should be familiar with, and aware of the potential pitfalls, in exchanging property between related parties. The use of a Qualified Intermediary familiar with the rules and legal precedence in dealing with this advanced topic can be of assistance in handling a related party exchange appropriately.

Qualified Escrow Agreements for Intermediaries

A number of states have instituted regulation for the Qualified Intermediary industry. Nevada, Idaho, California, Colorado, Washington, Maine and Oregon have all passed legislation. A number of other states are looking at adding some law(s) to protect taxpayers in the face of 1031 exchange facilitator fraud and losses.

Existing state law in California, Colorado and Washington as well as upcoming 1031 laws in Maine (went into effect Sept 12, 2009) and Oregon (effective January 1, 2010) require Qualified Intermediaries to:

a) Maintain fidelity bond (typically not less than $1 M), or;

b) Post deposits of cash or letters of credit equal to the amount of the fidelity bond required, or;

c) Hold all client funds in Qualified Escrow or Qualified Trust accounts which require the signatures of both the QI & taxpayer to authorize any disbursements.

As a result of the aforementioned industry losses - and the subsequent insurance claims - many Qualified Intermediaries have recently been unable to obtain option a) - a fidelity bond. If you are looking at doing an exchange, you should ask your exchange provider to provide a copy of the Fidelity Bond Evidence of Insurance to ensure your Intemediary is complying with the fidelity bond requirement. Make sure, if you are acting as a Qualified Intermediary, you are in compliance with these laws!

If your 1031 exchange provider does not have bonding, they must either post cash or a letter of credit with the state or use a Qualified Escrow account. Qualified Escrow accounts are held at a third party escrow agency and provide the greatest level of protection against fraud or missing funds. The escrow agent will only invest the proceeds according to the Agreement. They will also require signatures of both the Qualified Intermediary and the taxpayer client before any movement of those funds takes place.

If you are considering completing a 1031 exchange (or are a Qualified Intermediary without bonding) and in need of establishing a Qualified Escrow, FirstBank Escrow Services and their escrow officers can provide a Qualified Escrow Agreement that is specific to the 1031 exchange. Along with protecting the integrity of your exchange, FirstBank’s team of escrow specialists can work with you to establish an escrow contract that simplifies your risk mitigation requirements and meets your transaction needs. Client escrow accounts are individually segregated and held securely in FDIC-insured deposit accounts. FirstBank Escrow Services provides rapid review and turnaround of the agreement to ensure your transaction closes quickly.

If you or your Qualified Intermediary have need for a Qualified Escrow, please contact one of FirstBank's escrow officers for additional information at 800-964-3444.

Negative Equity Mortgages and Reverse Exchanges

A recent WSJ report indicates that more than 32% of all mortgaged properties in the United States were in negative or near equity position as of June 30,2009. An additional 2.5 million mortgaged properties were approaching negative equity.

The five states with the largest negative equity share accounted for nearly half the nation's remaining states. Nevada, Arizona and and Florida had the largest number of negative equity mortgages. California and Michigan were the other top-ranked states for negative equity loans.

Negative equity - also known as "underwater" or "upside down" - means the borrower owes more on a mortgage than the home is worth. Near negative equity is when mortgages are within 5 percent of being in a negative equity position. Negative equity can occur because of a decline in value, an increase in mortgage debt or a combination of both.

While negative equity continues to be the dominant driver of the mortgage market because it leads to foreclosures, the good news is it actually declined slightly this quarter. Other recent news indicates home price declines are moderating or flattening - possibly indicating we are at the low point in the cycle. Of course, continued bad news in unemployment figures, a worsening commercial real estate market and cold weather seasonality could lead to further declines.

We've noticed a a couple of interesting trends in this negative equity market. It appears a growing number of our long-term, real estate investor clients feel it is the right time to get back in the real estate market and make additional purchases. The trouble they are now finding is that many of the lender-owned properties are receiving multiple offers or it is taking some time to get closed. The other interesting observation is that it still seems somewhat difficult to obtain financing. We've had a number of exchanges that weren't completed because lenders were unwilling or unable to lend on replacement property.

If you are considering buying, and find that perfect property, it may not be wise to wait until your sale occurs. This is where a reverse exchange may make sense. By having your replacement property already lined up and financed, your exchange will not fail because you were continually getting outbid in what appears to be a fabulous opportunity or because of an inability to obtain timely financing. For more information on the benefits of a reverse exchange and how 1031 Corporation, as a bank-owned QI, is uniquely positioned to assist with your reverse exchange, please give us a call at 888-367-1031.

Buy Real Estate With Your IRA Or 401(k)

Since it's my birthday (not telling what number!), I thought I'd take the day off from blogging and publish an informative piece from one of our business partners. Entrust Arizona specializes in record keeping services for individuals and small business owners who wish to include non-traditional assets within their tax-deferred and tax-free portfolios. The following was provided by Timarie McClendon, director of business development with Entrust Arizona.

It’s a common misconception that the only investments allowed in an IRA or 401(k) is stocks, bonds, and mutual funds. The truth is that broader investment options, including real estate, have been available to the public since 1975. The key is to house your IRA or 401(k) at a company that will allow you to invest in real estate. All real estate investing with your IRA or 401(k) is legal - from single family residences to multi family, raw land, developed land, commercial property and even international real estate.

Self-directed retirement plans have quickly become the talk of the real estate community. Not only are real estate professionals self-directing their own IRA’s into property and projects, they are also using their knowledge about these plans to generate more business.

Don’t be confused by the marketing term “self-directed.” All brokerage firms will offer you their version of self directed. This means you can self directed your money into any of the stocks, bonds or mutual funds they offer. But…..that is where your investment choices end. Finding a truly self-directed administrative firm is not difficult. Some refer to this specific type of IRA as a “Real Estate IRA.” While this is not technically the legal description of a real estate investment within an IRA you can see how this might be the perfect description for the investor who is new to this option.

Understand these real estate investments are just that...investments. The real estate investment must be one that is an “arms-length” transaction. This means that the IRA account holder, as well as certain family members and business associates (disqualified persons), cannot live in a property, rent office space in a property, provide a service, or be involved in transactions in which the IRA buys or sells the property. The critical issue for many is making sure the property remains strictly an investment by avoiding self-dealing or prohibited transactions with family members or business associates. And an investor needs to be aware that all expenses, fees, etc. will have to be paid out of the IRA.

Retirement accounts can partner together in an investment. Utilize the investment power of multiple retirement accounts from people you trust and with whom you may already be doing business. Your IRA or 401(k) can even get a mortgage! You can partner your IRA with a 1031 exchange. You may also partner multiple IRA or 401(k) accounts or even partner personal monies!

You may hear false objections from uninformed advisors such as “that’s illegal”, “it’s too complicated” or “I’ve never heard of that.” Simply put, an IRA is a Trust. It’s that simple. If you understand a Trust, you understand an IRA. To simplify things even further, the IRS code is not written to specifically address what you CAN invest in. It is written to address what you CANNOT invest in. The IRS only prohibits two types of investment transactions - collectibles and life insurance.

You can use your retirement account to invest in real estate and harvest the same tax benefits of the IRA you may currently have invested in the stock market. Self-directed IRA administrative companies function just like your brokerage firms except that they specialize in alternative assets as opposed to securities.

For more information about self-directed IRAs and tax-deferred real estate investing, please take a look at Entrust Arizona's website or give them a call at (480) 306-8404.

Maine Adds 1031 Exchange Intermediary Regulation

The state of Maine recently added it's name to a growing number of states instituting 1031 exchange Qualified Intermediary (QI) regulation. Maine Public Law, Regulation of Exchange Facilitators, was enacted by the Maine Legislature in April and will go into effect on Sept 12, 2009.

The new law utilized much of the language we've seen from a number of western states that have been early in adopting new 1031 regulation. Like other states, the Maine law prohibits commingling of exchange funds with operating funds of the QI, but does not require the segregation of each client exchange account (which we strongly support). The new law prohibits any loans to the QI or affiliated person or entity, and requires that exchange funds be invested in a manner that will ensure liquidity and preservation of the principal. Similar to the recently passed QI bills out west, the Maine law also requires ten day notice of any change in control of the QI.

It does require a lower fidelity bonding and errors and ommissions (E &O) insurance coverage that we've seen in other states. The fidelity bonding threshold is $250,000. The Maine act allows the QI, in lieu of bonding, cash deposits or irrevocable letter of credit in that amount or the use of a qualified trust or escrow account. E&O coverage of $100,000 is required (or in lieu thereof cash deposits or irrevocable letter of credit in that amount).

The Maine law does differ in that it requires annual licensure of any person acting as QI for relinquished property in the state. We've written previously about other state licensure provisions being passed. While licensure may allow the state to keep track of those that are acting as QIs in the state, it does little to protect a consumer against fraud until it is too late.

As we've seen in other failed QI cases, having minimal fidelity bonding and E & O insurance doesn't provide as much security to the client as one would think. Bonding and/or insurance protects the firm, not clients of the QI firm. In addition, each act of fraud is not necessarily considered a "per occurance" event so the bonding may fall considerably short of protecting exchange clients.

While each state has, thus far, adopted segregation of client funds from operating funds, we've yet to see a state adopt segregation of each individual client escrow account. This is a recurring issue in the bankruptcies and subsequent legal procedings that have occured in the 1031 Tax Group and the LandAmerica Exchange cases. Clients of failed QIs that do not segregate - and distinctly identify the segregation of funds in their exchange agreement - will, unfortunately, learn that their interest is pooled together in a bankruptcy case as just another unsecured creditor. Since the funds are commonly "pooled" for greater investment returns, individual client funds are not protected as clearly being 'in trust for' a specific client.

Only segregated accounts and an exchange agreement that clearly makes use of segregation language can ultimately provide protection for clients of Qualified Intermediaries that sell. Of course, due diligence should be performed to make sure you know the financial condition of the QI you chose. Publically available financial statements, forthcoming answers to questions of segregation and investment policy/practices and a solid exchange agreement should all be provided.

If you've interest in discussing provisions of this new state law, or any other pending or passed exchange facilitator regulation, the Federation of Exchange Accommodators is working hard to balance the interests of clients and industry member firms to maximize protection of clients while minimizing the regulatory burden/costs and would be happy to answer many of the questions. We at 1031 Corporation would be happy to answer any questions you might have in selecting a Qualified Intermediary or information specific on how we protect our client funds. Give us a call today at 888-367-1031.

1031 Corporation is Going Green!

Going green is easy with a 1031 exchange. Green as in the Three R's - Reducing, Reusing and Recycling your capital gain tax dollars! The 1031 Exchange option is the perfect “green” way to hold onto your money and reinvest it into another like kind investment. Taxpayers should never have to pay income taxes on the sale of property if they intend to reinvest the proceeds in similar or like-kind property.

Through an IRS tax-deferred exchange, you are able to reduce your tax liability. A 1031 exchange provides the ability to defer the capital gains tax with the purchase of like-kind replacement property that would have been due and payable. For a real estate exchange, like-kind replacement property means any improved or unimproved real estate held for income, investment or business use.

Your Qualified Intermediary must hold and forward net proceeds from the sale of your property to the purchase of the replacement property. If you receive cash or have a trade down in value you may have "Boot". Boot is the money received or the debt reduction received by the taxpayer in an exchange. The rule of thumb for avoiding "boot" is to always replace with property of equal or greater value than the relinquished property.

The tax basis of the old property becomes the new tax basis in the replacement property. If you “bought equal,” the basis in the new property is the same as it was on the old property. In a 1031 exchange, the basis rolls forward from the old property to the new property. If your replacement is a trade up in value you will be able to increase your basis by the amount of the trade up. This trade up allows you to increase the amount available to be depreciated.

Just remember the three R's for going green are Reduce, Reuse, Recycle. 1031 Corporation is ready to assist you in Reducing your tax liability, Reusing your proceeds from the sale of your relinquished property on the purchase of your replacement property and Recycling your ability to depreciate by purchasing up in value on the replacement. Are you ready to go green? Give us a call today at 888-367-1031.

FirstBank, 1031 Corporation's Parent, Net Income Up 7%

FirstBank Holding Company, parent of 1031 Corporation, announced first half 2009 earnings grew amid strong loan and customer deposit growth. The bank earned $72.3 million for the first six months of the year. This figure is up 7 percent from the same six-month period in 2008. The company’s earnings per share were up 9 percent from a year ago $556.61.

“FirstBank performed exceptionally well through the first half of 2009, due to our focus on quality loan acquisition, consistent deposit growth and our continued ability to attract new customers,” said President and CEO John Ikard.

Total assets were $9.55 billion on June 30, up 3 percent, and total deposits increased by eleven percent to $8.71 billion. Total loans grew to $4.1 billion - an increase of 14 percent. Return on average shareholder equity was 22.6% annualized for the first six months of 2009.

FirstBank is the largest locally-owned bank in Colorado. The bank operates 121 locations in Colorado, seven in Arizona and five in California and is the parent company of 1031 Corporation Exchange Professionals. It does not originate, hold or purchase subprime mortgage loans or securities, which has helped the company avoid the type of credit losses that have hurt other financial institutions in the past couple of years.

1031 Corporation, a subsidiary of FirstBank, holds each client's exchange funds in a segregated money market account at one of the 25 bank charters. For net exchange proceeds in excess of $250,000, 1031 Corporation can deposit client funds in separate accounts at any of the 25 bank charters FirstBank maintains. This allows 1031 Corporation to provide FDIC insurance of up to $6.25 M per client. For more information on setting up your next exchange, please call us at 888-367-1031.

Subdivided land treated as capital gain

Last month, the tax court ruled on a case (TC Memo. 2009-142) involving the issue of a parcel of land that was subdivided and sold over a period of time. At stake was the issue of whether the taxpayers were required to pay ordinary income on the investment property versus being treated to a more preferential capital gains treatment. It has implications for those considering a 1031 exchange that face a similar issue.

The case involved a couple that had purchased a 14 acre parcel to build their primary residence. Prior to building, the couple decided they would prefer to have neighbors rather than being so remote. They made the decision to subdivide the former agricultural property into ten parcels.

Over the next four years, the couple went thru the re-zoning process, created a homeowners association and sold seven of the lots. When the couple reported the income as capital gain, the IRS claimed that, with the sale of multiple lots, their status had changed from investor to dealer and that all profit constituted ordinary income due.

Eseentially, because a) their advertising was nothing much more than a simple wooden sign, b) they sold the lots primarily to acquaintances and c) they were not considered real estate developers (having ownership in a non-development, successful business), the tax court held that the gain qualified for capital gains treatment.

The case provides insight with respect to 1031 exchanges as well. It, theoretically, follows that if the taxpayer had chosen to exchange into another qualifying real estate investment - rather than simply sell the lots and pay the capital gains tax - they could have deferred the gain under section 1031.

We are occasionally asked what qualifies as "held for" investment and what type of exchange does not qualify due to the taxpayer being viewed as a dealer (i.e. - developer) versus an investor.

The court laid out nine factors that determined the property status:

1. The taxpayer's purpose and reason for property acquisition.
2. The purpose for subsequently holding the property.
3. The taxpayer's everyday business.
4. The frequency and substantially of sales.
5. The extent of improvements.
6. The extensive use of advertising.
7. The existence of a business office for property sales.
8. The degree of supervision over sales agents.
9. The time habitually devoted to sales.

It would appear that a taxpayer that can meet the above factors, and considering a like kind exchange, could reasonably justify they are not a developer/dealer and qualify for deferred treatment under section 1031. While each case is different (and as we caution - the specific circumstances should be reviewed with a tax professional before proceeding), the case does provide some important insight into what might be possible.

Have a similar issue involving a 1031 exchange? Give 1031 Corporation a call at 888-367-1031. The phone call and conversation are free.

Is your Qualified Intermediary an FEA member?

Do you really know the structure and background of the company with whom you are placing your 1031 exchange proceeds? In the tough economy, that all of us are facing, is your Qualified Intermediary (QI) looking out for your best interests?

1031 Corporation has been active in the QI business for 19 years. We are a member of the Federation of Exchange Accommodators (FEA). FEA is the only national trade association that represents like kind exchange professionals. Established in 1989, the FEA was organized to promote the discussion of ideas and innovations in the industry, to establish and promote ethical standards of conduct, to offer education to its members, and to work toward the development of uniformity of practice and terminology within the exchange profession. Professionals that are members of this association enjoy membership benefits that include:

· Legislative and regulatory updates regarding the 1031 industry

· Educational conferences

· Enhanced professional credibility

· Only FEA Members are eligible to earn the distinguished Certified Exchange Specialist® designation

· Access to fidelity bonding and errors and omissions (E&O) insurance

As exchange professionals, 1031 Corporation offers the advantage of being a FEA member to our clients. Currently there are only 208 Company and Individual members in the FEA association. Is your Qualified Intermediary one of them?

IRS Considering Relief for Taxpayers Caught Up With Bankrupt QIs

Large and small 1031 Exchange Qualified Intermediaries (QIs) have gone into bankruptcy in the last couple of years for a variety of reasons, including frozen liquidity in the financial markets and questionable diversion of exchange funds to fund loans to related companies. This has caused taxpayers to not only lose their 1031 exchange funds but to also have income tax liabilities for incomplete replacements under §1031 for the sale of their real estate.

Congressmen and Senators have been receiving complaints from their constituents for some kind of tax relief in these circumstances and the IRS has been receiving appeals to do something about this. As a result, the Internal Revenue Service is notifying Congressmen and Senators that it is working on some kind of relief for taxpayers who have been unable to timely complete a like-kind exchange because the used a Qualified Intermediary that went bankrupt.

Up to now, the position of the IRS has been that a sale of property is taxable if the 1031 Exchange fails due to a bankrupt QI with no taxpayer relief.

The IRS has also said that if a taxpayer sustains a loss of exchange funds due to a bankrupt QI that is not compensated for by insurance or otherwise, he can deduct the loss from gross income under Code Section 165(a), but only in the year the loss was sustained. Sometimes the loss is sustained in the year following the tax year of sale of the relinquished property and is not available for offset of the taxable gain on the sale of the relinquished property.

As a result of all the controversy over bankrupt QIs, the Internal Revenue Service is now saying that it is contemplating some type of relief for affected taxpayers. The IRS has been promising action on this issue since the fall of 2007 when the real estate market started heading south in many areas.

We’ll have to wait and see.

Money Crooks Beware

Yesterday in New York, a judge sentenced Bernie Madoff to the maximum penalty of 150 years in prison for his fraud and ponzi scheme that bilked investors out of some $65 Billion. The court heard testimony from nine investors - some of whom have lost their entire life savings from the case. While the size of this case is so incredible and may not be repeated, it is, unfortunately, probably not the last time this sort of thing will happen. It certainly isn't the first and reminded me of issues in our own industry.

Earlier I'd written about the case of Ed Okun. While a scheme like Madoff's gets all the press because of the size and severity of the case, Mr Okun was no less guilty of frauding investors - some, again, out of their lifelong savings. In a scheme designed to defraud clients out of millions of dollars through false pretenses, Okun started buying 1031 exchange companies and, over the course of two years, began raiding the client accounts. He used the money to buy more 1031 Qualified Intermediary companies to keep the ponzi scheme running as well as fund his lavish personal lifestyle. Mr Okun will be sentenced in August and faces up to 400 years in prison.

While the money is gone, at least the courts are finding the heart and determination to sentence these "white collar" criminals to the remainder of their lives in prison. It does nothing to bring back the life savings of the former clients from whom they stole but at least the crooks are paying for what they've done. Maybe, just maybe, it will stop a few future would-be criminals from making the same mistake. Perhaps too, it will bring further highlight to the fact that you need to know who you are dealing with and do your due diligence before allowing them access to your money.

1031 exchange Real Estate radio show

This Wednesday, June 24th from noon to 1 PM Pacific time, 1031 Corporation will be on the air live at KFNN 1510 in Phoenix. Carol Croft and I are guests on a show hosted by Entrust Arizona's JP Dahdah and Timarie McClendon.

We plan on discussing how 1031 exchanges provide a way to defer capital gains taxes and preserve more of your principal in your real estate investments. We will also be discussing some recent trends in the industry and provide some information on the legislative landscape as it relates to Qualified Intermediaries.

You can listen to the show live here or, if you've missed this post or are not available at that time, Entrust Arizona provides a link to past shows they've hosted.

We hope you'll take the time to listen and, perhaps, increase your financial literacy as it relates to this important tax strategy!

Also, if you have a real estate license in Arizona, we are offering, along with Entrust Arizona, Four Hour Continuing Education course on Thursday, June 25th from 11 AM to 3 PM. We even provide lunch! The class is in Entrust's state-of-the-art facility at 20860 N Tatum Blvd, Ste 240 in Phoenix.

The first 2 hours is our class offering, Everything You Wanted to Know About 1031 Exchanges. In addition to providing the basic rules of IRC Section 1031, this class provides a basic understanding of the Reverse and Improvement exchange process. We also discuss the role of the Qualified Intermediary and investor motivations for a 1031 exchange. This class also highlights strategies involving the section 121 Primary Residence rules used in combination with a 1031 exchange.

The second 2 hours will be Entrust's class, Show Me The Money! How to Buy Real Estate with Your IRA/401k. Did you know you could invest in real estate with your IRA? Do your clients? You can even get a mortgage with your IRA or partner together with other retirement accounts or individuals. Your choices are endless. This workshop teaches real estate agents & brokers how to tap into the trillions of dollars available within retirement plans. The class teaches attendees the important elements of Self-Directed IRAs so they can add this hot topic to their current marketing plan. You will walk away with a clear understanding of how you can position yourself in a true advisory role with your clients.

For more information about 1031 Corporation, please call us at 888-367-1031. For more information about Entrust Arizona, please call (480) 306-8404.

Deceased Sister’s Trust is not Related Party to Siblings

Related parties are defined by IRC Section 267(b) or 707(b) of the IRS code. Special rules apply to related parties who are involved in a 1031 exchange.

If related parties exchange like-kind property with each other each party must hold the property received for two years before any subsequent disposition occurs, and

A taxpayer cannot sell to an unrelated party and receive replacement property from a related party.

Related parties include ancestors, descendents, siblings and spouses. Related parties do not include the spouse or children of a sibling. A taxpayer doing an exchange with a spouse or child of a sibling is not subject to the related party restrictions and requirements.

In a recent Private Letter Ruling ( PLR 2009192007), a trust for a deceased sibling’s spouse and children was held to not be a “related party” to the surviving siblings for the purposes of Section 1031. This allowed a portion of the inherited farm ownership to be sold while also allowing the other two siblings to retain their ownership and continuing their taxable gain deference.

In this case, the Taxpayer and two siblings co-owned equal shares of farmland as tenants in common. Ownership was held in trusts for each of them (Trusts A, B and C). Child C died and beneficial ownership of assets in trust passed to Child C’s surviving spouse and children. Trust C now wanted to sell its share of the farmland.

The tenancy in common interest of each trust was converted to fee simple interests in the same property through subdivision. This was technically an exchange between the three trusts. After the exchange of the undivided interests for whole parcels, the husband of the deceased sister, via Trust C, quickly sold its parcel to an outside, third party. The other two siblings retained their respective parcels. If the deceased sibling's trust was a 'related party' under section 1031, the exchange of the interests for the whole parcels could have been found to be a taxable event to the other two siblings due to nonn-compliance of the two year-rule reference above.

Although her trust sold within two years of the swap in ownership, the IRS said the sale did not trigger tax on the exchange by the other two trusts. The ruling held that the exchange and subsequent sale was not a transaction to which section 1031 applies because the sibling taxpayers are not related to the Trust within the meaning of section 1031.

This ruling provides some insight into who is NOT considered a Related Party within the context of 1031 exchanges. However, rules on related parties should be reviewed with your tax professional before relying on any Private Letter Ruling for definition. You may also give us a call at 888-367-1031 if you have any questions regarding 1031 exchanges between related parties.

Renting Real Estate to a Related Corporation May Cause PAL Rule Tax Problems

The passive activity loss (PAL) rules were enacted as part of the Tax Reform Act of 1986. They were intended to prevent taxpayers from using losses and credits from tax shelters to offset income from such sources as wages, interest and dividends. Congress felt that taxpayers who were simply investors in a business activity (and not actively participating) should use deductible tax benefits only against income from such passive activities.

Rental real estate activities are passive activities subject to the passive activity rules. Losses from rental activities, after including expenses such as interest and depreciation, are not deductible unless a taxpayer has passive activity income from other sources. There is an exception. Taxpayers are generally allowed to take a net deduction of $25,000 from ordinary income if they actively participate in the rental activity. This special rule is phased out for high-income taxpayers.

Taxpayers with passive activity losses have a natural desire to create sources of passive activity income which can be used for deduction of losses from other passive activities. Taxpayers who are doing business as a corporation frequently own the real property which the corporation uses and receive rents from the corporation for the property use. This lease income to their corporation is reported on their individual income tax return as rent income. Taxpayers would normally expect that this income is passive activity income because rental activities are defined as passive activities.

However, the IRS does not like the possibility that a taxpayer could create artificial passive income by renting property to a controlled corporation and use this income to offset losses from other passive activity investments. The sole owner/taxpayer of an S Corporation could also compensate himself through the artificial use of rent and diminish W-2 compensation (which is subject to payroll taxes). To stop this perceived abuse possibility, the IRS recently issued new regulations classifying net rental income from a corporation owned by the taxpayer as active income (and not passive activity income). Therefore, rents from a corporation owned by the taxpayer could not be used to offset losses from other passive activity investments.

But what happens if the rents from the taxpayer-owned corporation result in a rental loss after rental-related expenses? The IRS has said the activity IS a passive activity and losses can only be deducted against other passive activity income. If there is no passive activity income from other sources, the loss cannot be used to shelter ordinary income.

In a recent Tax Court Case ( Senra, TC Memo. 2009-79) the taxpayer argued that a rental loss should be deductible against wages the taxpayer reported from the same corporate activity. The taxpayer argued that the rental activity was related to the business activity of the corporation and, when combined, the two activities formed one economic unit. They argued that it should be treated as a single activity for purposes of measuring gain and loss for netting purposes.

The Tax Court disagreed and said that the passive activity loss rules cannot be escaped under the "one economic unit" argument. The taxpayers were stuck with a rental loss which could not be used to offset wage income from the same corporation. This court case is something to consider when dealing with a related party transaction between a controlling taxpayer and a corporation having rental income.

When dealing with related parties, the water can get murky. 1031 Corporation has information on exchanging properties between related parties and can help you understand the issues that may be present. See our website for information on structuring issues when parties related to each other are buying and selling and making efforts to defer capital gains taxes. Of course, you can always give us a call at 888-367-1031. While we can't advise you on passive activity loss rules, we can provide related party exchange-related consultation...and both the information and phone call are free!

How do you report a 1031 Like-Kind Exchange to the IRS?

We often are asked for assistance from taxpayers and accountants on how to report a like-kind exchange. While we are unable to give tax advice, we do have obvious experience with this somewhat complicated and difficult form to complete. So, we can provide some assistance with YOUR completion of the form.

You must report an exchange to the IRS on Form 8824 and file it with your tax return for the year in which the exchange occurred. For example, if you sold property on November 5, 2008 as part of a 1031 exchange, and you purchased the new property on February 7, 2009, you would need to file Form 8824 with your 2008 tax return. This is a two page form that you submit with your federal tax return to report the details of your 1031 exchange.

Form 8824 asks for:

·Descriptions of the properties exchanged

·Dates that replacement properties were identified and transferred

·Any relationship between the parties to the exchange

·Value of the like-kind and other property received

·Gain or loss on sale of other (non-like-kind) property relinquished

·Cash received or paid; liabilities relieved or assumed

·Adjusted basis of like-kind property relinquished; realized gain

When you complete an exchange with 1031 Corporation you will receive a summary of your 1031 Exchange. Included with this summary is a worksheet to assist you in completing the Form 8824. Our worksheet and the 8824 form are also provided on our website under Accounting Topics.

Of course, we'll also walk you through all the steps of the exchange and make you aware of any obstacles and work with you to hurdle them. Plus, our clients receive pre- and post-consultation at no additional cost. That comes in handy when you are trying to fill out that Form 8824.

Give us a call today at 888-367-1031 with your 1031 exchange needs!

1031 Drop and Swap Distributions Receiving New IRS Attention

Partnerships which are selling property often have one or more partners who want to structure a 1031 exchange for their share of the property owned by the partnership (or LLC). Sometimes all of the partners will wish to go separate ways and either sell for cash or do their own 1031 exchange. Sometimes one or two partners of a multi-partner firm will wish to leave the partnership arrangement.

A sale of a partnership interest does not qualify for a 1031 exchange. So, individual partners who want to structure a 1031 exchange for the sale of their interest in the partnership real estate need to position themselves appropriately. They can do so by receiving a deed to their share of the real estate from the partnership. This is done by the partnership conveying a tenancy-in-common interest in the real estate to the individual partner in redemption of his interest in the partnership. This leaves the real estate co-owned by the partnership and the individual member of the partnership who received the deed. Each of the co-owners proceeds to close on the sale of the real estate to the buyer and the individual member proceeds to do a 1031 exchange for the sale of his interest. Of course, the partnership and its remaining members are also positioned to do their own 1031 exchange if they wish to do so. This procedure is known in the industry as a “Drop & Swap.”

The Drop & Swap commonly takes place at the same closing table at which the property is conveyed to the buyer with back-to-back closings. The individual member partner who received a tenancy-in-common deed from the partnership has, technically, only owned his piece of the for sale real estate a few minutes. The first question that comes up is whether a few minutes of ownership is adequate for qualification of the sale for a 1031 exchange. The requirements for a 1031 exchange include the condition that the property being sold has to have been held by the taxpayer for investment or business purposes. This is commonly known as the “held-for requirement.” The Code and Regulations provide no guidance on how long a taxpayer has to have “held” the property for the required purposes.

In the past, the IRS has challenged taxpayers who have done a Drop & Swap with only momentary ownership prior to a sale. However, the courts have been favorable to the taxpayer holding that a distribution of property to a taxpayer is merely continuing the investment in a different form. In recent years, the IRS has not been aggressive in challenging Drop & Swaps.

However, commencing with 2008, Partnership Income Tax Returns include two new questions in Schedule B –

13. Check this box, if during the current or prior tax year, the partnership distributed any property received in a like-kind exchange or contributed such property to another entity (including a disregarded entity).

14. At any time during the taxpayer year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in partnership property?

Based on these new questions - which clearly include Drop & Swaps, it appears that the IRS wants to know how frequently this is being done and is giving it their attention. Will the IRS select partnership returns for audit based on the answers to these questions? We don’t know. At a recent industry conference, an IRS agent indicated it was Treasury and not the IRS that had added these questions. Further, the IRS has offered no explanation for these new questions. Whatever the case, it appears some study is being done on the subject.

Taxpayers involved in a Drop & Swap will have to accept some risk of challenge by the IRS based on these new questions on the Partnership Income Tax Return. Taxpayers should always consult with their tax and law professionals if they are contemplating a Drop & Swap for consultation on this issue as well as other business and tax issues affecting the partnership and its members.

For more answers to your questions regarding partnership interests and 1031 exchanges, please visit our website or give us a call at 888-367-1031.

Strong Ethical Foundations Important in 1031

Michele Falivene recently wrote an article for the banking industry about ethics. In it she states, “I have found there is a great deal of finger pointing going on these days as we grapple with the causes and impacts of the recession. Employees, businesses, government officials and consumers want to know who to blame and how to hold someone accountable for their losses. But it’s that lack of accountability and a very public absence of personal responsibility that has left many people without the answers they’re looking for.”

While we can’t rewrite the past for those 1031 exchange companies who engaged in questionable investment practices and pooled exchange funds, we can certainly revisit the principles that a Qualified Intermediary (QI) should offer - uncompromised integrity and a sound, ethical foundation.

A well-built, ethical foundation should be a vital part of the exchange company that you choose. A principled QI will explain their company’s commitment to best practices and make ethical considerations a primary decision-making factor. Detailed questions should be asked of the 1031 intermediary that you are considering using. Immediate answers for those questions should be forthcoming. You should be left having no lingering doubts.

1031 Corporation has built it’s foundation on these standards. As Henry Kravis said, “If you build that foundation - the moral and the ethical foundation as well as the business foundation and the experience foundation - the building won’t crumble.” In light of recent failures or “crumbling” in the 1031 exchange industry, 1031 Corporation is still standing strong. You can count on 1031 Corporation to provide our clients uncompromised integrity from a sound ethical foundation. For your 1031 exchange needs, please give us a call today at 888-367-1031.

Hold Open Title Policy Can Benefit your 1031 Exchange

What is a Hold Open?
A Hold Open is a title insurance term used for real estate transactions where the title company that insures the initial sale agrees to insure another sale of the same property within 24 months of the original sale. They are used in reverse 1031 exchanges to avoid the cost of two separate policies. Investors might also use them in a "flip" transaction.

There are three parties involved in a completed Hold Open transaction: the original seller, the middle buyer (the person requesting the Hold Open or, in the case of a reverse exchange, your Exchange Accommodation Titleholder or EAT), and the final purchaser (the exchanging client. Hold Opens are often associated with reverse 1031 exchanges and fixer-upper properties, but this is not a requirement for a buyer to request a Hold Open. Investment properties can be held open from one sale to the next and Hold Opens are also available for short-term owners who simply know they will be selling the property within two years.

Benefits of a Hold Open
A Hold Open ultimately saves money for the buyer in a 1031 exchange. Since the buyer knows that the purchased property will be resold within two years, the title company can hold the file open for the resale at a fraction of the cost the buyer would have paid — even with a discounted reissue rate — in title insurance premiums.

The process works like this: The original seller pays the applicable title insurance premium for the initial sale to insure the middle buyer. The middle buyer then pays only a small percentage (depending on the underwriter) of the full basic premium charge in order for the title company to keep the file open, and no title insurance policy is issued at this time. In the case of a reverse exchange, the client pays all closing costs associated with the initial purchase so they ultimately save title cost on the subsequent exchange.

When the middle buyer (EAT) sells the property (back to the exchanging client), they pay the difference in premiums between their purchase price and the selling price on the second half of the Hold Open. A title policy is issued only to the final purchaser.

For example, a Denver residential property purchased for $250,000 would have a full premium of $1,265. The buyer (via the EAT) would pay an additional Hold Open fee of $126 to keep the file open. Upon the sale of the relinquished property in the exchange, the EAT sells the house back to the taxpayer for the same price. While this second sale would normally trigger the need for new title insurance (costing another $771 at the standard 50% reissue rate), the up-front, 10% payment of the Hold Open policy would result in no additional title insurance premium.

In the case of a fix and flip, hopefully, the property was sold for more. Let's say it was subsequently cleaned up and sold for $300,000. In this case, the seller would pay the difference in premiums, which would be $92. His total title charge would be $218 ($126 for the Hold Open and $92 for the increased coverage over the original $250,000 purchase), saving $553 over the $771 he would have paid if he had simply used a standard 50% reissue rate.

Conditions for a Hold Open
A property is eligible for Hold Open status only if the following conditions are met:

• A commitment to insure the final purchaser is issued after recording the initial conveyance to the middle buyer. This is in lieu of a policy of title insurance to the middle buyer, or EAT. Any adverse matters that are recorded or become known to the title company must be satisfied before the policy is issued.

• There must be a single resale transaction of the exact property as reflected on both the original commitment to the middle buyer (EAT) and the final policy to the final purchaser (the exchanging party). For example, the purchase of a duplex must be sold as a duplex, not sold as two separate units in the final conveyance.

• The middle buyer (the exchanging party's EAT) must sign an affidavit acknowledging that he is aware the property must be sold within two years or the Hold Open charge will be forfeited and the policy issued to the middle buyer.

• Both transactions must be insured through the same title company. The final purchase for the transaction initially held at one title company cannot be insured by another title company.

Property Value Increases
The Hold Open charge is based upon full value of the real estate or interest at time of the initial conveyance, with an additional charge of 10–25% (depending on the underwriter) of the basic premium based on the full value of the real estate or interest.

Upon closing of the resale within two years, the owner’s title policy will be issued to the final purchaser without additional cost. If there is an increase in the liability between the initial conveyance and the ultimate sale, a charge will be made based on the difference between the two liabilities calculated at the applicable schedule of rates.

Additional stipulations
The Hold Open is available only one time per transaction. If the resale to the final purchase is not recorded within 24 months of the date of the original sale, the policy of title insurance will be issued insuring the purchaser in the initial
sale in the amount originally committed. The Hold Open charge will be forfeited.

A potential drawback of the Hold Open procedure is that the middle buyer is not insured for any warranties of title that may be given in the deed to the final purchaser, since no owner’s policy is issued to the middle buyer.

Kyle Snyder of Land Title Guarantee Company has graciously provided much of the above information. If you have questions about Hold Open title policies, give Kyle a call at 303-393-4945. For your reverse exchange needs, please contact us at 888-367-1031.

FirstBank at the Colorado Rockies Season Opener

1031 Corporation is a wholly-owned subsidiary of FirstBank. While we try to highlight the safety and soundness of our parent company, the bank recently made an aerial effort to highlight its long-standing belief that fiscal responsibility starts with the way a company you do business with spends its money. This banner flew over LoDo Denver above Coors Field on the Colorado Rockies 2009 opening day last Friday.



In case you can't read the banner, it says: "This is the closest thing we have to a private jet"....with the FirstBank logo.



Oh, by the way, 1031 Corporation does aircraft exchanges...in case you are considering exchanging a single prop, like the one in the photo, for that private jet.

Have a great weekend!

Requirements of a 1031 Exchange

A tax-free real estate exchange is an important financial tool for investors looking to sell a property and reinvest in other real estate. The advantage of a 1031 exchange is that they allow taxpayers to sell income, investment or business property and replace it with like-kind property without having to pay Federal income tax on the transaction. The tax is deferred allowing the investor to reinvest the full proceeds of a sale into new investment(s).

First, the property being exchanged must qualify. Qualifying property is any real or personal property held for investment purposes or used in a taxpayer's trade or business. Any property used exclusively for personal use cannot be exchanged. Also, property acquired with the intent to immediately resell does not qualify.

Second, the replacement property must be like-kind to the relinquished property. In the case of personal property, what is like-kind can be a bit more challenging. The replacement property generally needs to be in the same asset class as the relinquished property. In real property, replacing like-kind property is easier to meet. A single family house can be exchanged for a condominium (or cooperative) unit. Raw land can be swapped for an office building or a farm can be exchanged for commercial or industrial property. A relinquished property in the United States must be replaced with property in the United States. Foreign property is like-kind to foreign property.

Next, a couple of deadlines must be met. The replacement property must be identified within 45 days from the date of sale and must be purchased within 180 days of the sale. The exchange will end if identification is not made within 45 days or if property is not purchased within 180 days.

Finally, the most important requirement of a successful 1031 exchange is that the taxpayer cannot receive (or control) any of the net sales proceeds from the relinquished property. All such proceeds must be held in escrow by a neutral party and must go directly into the purchase of the replacement property. Generally, a Qualified Intermediary is involved in the transaction.

If you have questions about additional requirements of your 1031 exchange, please see our Exchange Manual or give us a call at 888-367-1031.

1031 Exchange Classes and Continuing Education

1031 Corporation Exchange Professionals provides continuing education classes for Realtors, CPAs and Attorneys. We work with broker offices, title companies and real estate, accounting and legal trade associations to provide Continuing Education credit for 1031 exchange classes in Colorado (and very soon, Arizona and California). In conjunction with a couple self-directed IRA providers, we also provide a broader, tax deferred real estate investing class.

While many states now have a prescribed minimum requirements list that includes ethics and other "core" classes, a class involving 1031 exchange options, rules and procedures is a great way to add an interesting twist to your class offerings. It allows participants to hear something about a topic with which they may not be as familiar. It attracts agents, business associates or investor clients that might not normally attend a class offering and gives something of value to the agency or firm sponsors the course.

Carol Croft, Larry Jensen and I combine to offer our expertise and real life experiences to provide valuable insights into new strategies to defer capital gains. Carol has over fourteen years experience and she is a Certified Exchange Specialist. She's performed thousands of exchanges on behalf of our clients and has a number of real life examples that provide practical knowledge about how one goes about completing an exchange. Larry, as a Certified Public Accountant, is extremely knowledgeable about the technical and legal basis for many exchange strategies and concepts. While he is a former accounting firm partner and has more than 30 years accounting experience, he provides much more than a dry scholarly approach. Pretty interesting stories too...oh....me? I am just a former banker of seventeen years that really likes mixing real estate, financial concepts and saving money on taxes! All three of us love thinking "outside the box" and coming up with possible solutions to the most complex of 1031 exchange scenearios.

Our most popular class, a course titled Everything Your Ever Wanted to Know About 1031 Exchanges (I know, pretty lofty title, LOL) provides the basics of a like kind exchange in a format that allows interaction - all while informing in a very easy to follow, two hour format. We typically even work with a sponsor that partners by providing the facility or perhaps lunch. No better way to bring in a crowd than with free food! In these economic times, inexpensive, one-on-one marketing opportunities are effective. They provide the ability to converse face-to-face with those individuals that are actively positioning themselves to benefit during the next recovery cycle.

If you have questions about 1031 exchange classes or partnering with 1031 Corporation Exchange Professionals on education opportunities, please call us toll free at 1-888-367-1031.

Things a Lender's Counsel Thinks about in a Real Estate Transaction - Part 2

Last Friday, we covered the first six of the top things a Lender’s counsel thinks about regarding a commercial loan transaction. This weeks conclusion of that article provides the final items. This list is courtesy of Michael Fogel of the Florida law firm of Fogel and Pekale LLP.

7. Show me where the dead bodies are buried

Except for a condominium, it is almost the rule that some form of environmental questionnaire, analysis, study, or report will be required by the lender. If you think buyers don’t like surprises, then you’ll not be surprised to learn that lenders dislike them even more. You should know that there are very few exceptions to the lender’s requirement that this pre-closing condition meet the lender counsel’s satisfaction. Quite simply, the lender will not fund the loan without it. While an environmental questionnaire is relatively quick to prepare, an environmental study (i.e., a Phase 1 Report) frequently is not. If any further analysis is required, that WILL take time. Therefore the best advice is, when the contract is fully executed and if the lender requires an environmental analysis, don’t delay. Order it today!

8. How’d they do that?

Ah...the appraisal. One of life’s great mysteries. Some how, some way, the property is given a value by those all-knowing, all-powerful prognosticators of worth: the appraisers. This may be one of the toughest jobs in the real estate industry. It takes experience and study and is critical to the loan process. Which means that the appraiser (like the surveyor) must meet the lender’s qualifications and the bank will (or will not) make its loan based upon the value the approved appraiser gives the subject property. The lender’s counsel will have this item as a high priority item on its Closing Checklist as the loan itself will not be done without the appraisal meeting the lender’s criteria.

9. The Kitchen Sink

Each commercial real estate transaction is unique and there are times when there are other important facts, terms, or conditions that are critical to disclose to the lender and its counsel very early in the process. The list is endless - virtually a kitchen sink of scenarios. For example, franchises and gas stations have very specific agreements that affect the use of the subject property and, therefore, are subject to the Lender’s review and approval. Other commercial properties may have tenants of all different sizes and leases of varied terms. There may be cross-access easements, deed or other use restrictions, property owner associations, zoning or code violation matters, like kind exchange documents. All of these are important to lender’s counsel and must be addressed in the initial pre-closing phases of the transaction. A delay in getting lender’s counsel information on any of these items may result in a delay of the closing, or perhaps closing will not happen at all, frustrating the buyer’s and the broker’s objectives and creating unwanted consequences.

10. I’ve got you covered

If you have lived in Florida for 5 minutes you know that property insurance is a very hot topic now and likely will be for some time to come. It one of the essential ingredients in “baking the closing cake”. It is extremely unlikely that buyer’s lender will close without the buyer obtaining insurance coverage acceptable to the lender. It is, therefore, important to have the buyer determine what the lender’s insurance requirements are as soon as possible then diligently pursue satisfying them. Insurance will most certainly be a pre-closing item on the lender counsel’s closing checklist. Get evidence of insurance coverage - paid in advance by the buyer - to the lender’s counsel. As we have all seen, the insurance market changes like the weather. Do not wait until the last minute on this matter.

10 (again). Show me the Money (Again)

While all of the pre-closing conditions are getting satisfied, keep your eye on
one of the last requirements - the buyer’s closing funds. Generally, the buyer shall be required to come to the closing with funds sufficient to close the transaction. Funds are usually in the form of a bank or cashier’s check, an attorney’s trust account check or are sent by wire transfer. It is not uncommon for buyers/borrowers to lose track of this requirement. They then have to scramble to come up with sufficient closing funds, thereby causing a myriad of issues on the eve or day of the closing!

While this article is written from the perspective of a lender’s counsel, you may notice that several of the top items are very important, even critical, to the buyer and its counsel. Accordingly, make sure that these items are delivered to such parties concurrently with the delivery thereof to lender and its counsel. If the broker can provide this information thoroughly and quickly, it can and most often does make the pre-closing part of the transaction proceed more quickly and efficiently. And getting the closing to occur, as we all know, is the main objective.

We'd like to thank Mr Fogel for granting us permission to use his insights. Please contact Mitchell at (561) 393-9707 with any questions or comments.