1031 Receiver Recovering Lost Funds

A couple of recent news reports from Las Vegas indicate that former clients of Southwest Exchange may receive a substantial portion of their 1031 exchange funds. Jeff German of the Las Vegas Sun reports that as much as $91.7 million of the $97.5 million previously thought lost has been recovered through settlements with insurance and banking partners of the firm.

This is a remarkable sum considering how it appeared almost two years ago. Reportedly, Southwest Exchange acquirer, Don McGhan, invested nearly half to purchase a breast implant manufacturer and spent millions more to support his lavish personal lifestyle.

Of course, the news is tempered. As much as 25% of the money could go to attorneys that assisted in obtaining the money. Also, those taxpayers did not receive any relief from the IRS on the capital gain tax that they were required to pay (since their exchange could not be completed within their original 180 day window). Still, the news is much more favorable than anticipated and much better than what the latest is on the 1031 Tax Group/Ed Okun scandal.

As we've highlighted before, the central theme to both these issues (as well as the recent Summit 1031 Exchange failure) is the borrowing of monies that were placed in trust for clients into closely held and irresponsible, or downright fraudulent, investments. Both McGhan and Okun were acquirers who found a way to loan themselves millions of client exchange funds. Summit was owned by a sponsor of Tenant In Common Interests that was loaning its client funds to the parent thereby allowing it to leverage real estate.

Recent provisions in California, and now pending in Colorado, will make this activity illegal. No longer will Qualified Intermediaries be allowed to "loan" funds to an affiliate. This is an important element in all these unfortunate scandals. By providing sensible legislation that protects the client and allows ethical Intermediary firms to do business cost effectively, California and Colorado are taking the lead in protecting consumers and business alike.

Development Rights are Like Kind to Fee Interest in Real Estate

A newly released private letter ruling, PLR 200901020, reaffirms the IRS's view that development rights are a qualifying interest in real estate which can be like kind to a fee and other interests in real estate for purposes of an exchange under IRC Section 1031. PLR 200805012 previously affirmed the same. Accordingly, development rights can be exchanged for a fee interest in real estate and vice versa.

In order for development rights to be like kind to fee interest in real estate under IRC Section 1031, it is necessary for the state the rights are located in to view such rights as a real estate interest and for the rights to be in perpetuity (as distinguished from rights which are short-term or for a limited period of time). Perpetuity is important. Short-term rights may be an interest in real estate under state law but are not like kind to a fee interest in real estate under IRC Section1031. PLR 200901020 makes this clear.

A qualifying interest in real estate which can be like kind to a fee interest in real estate under IRC Section 1031 can include varying types of real estate interests. PLR 200901020 examines such other types of qualifying interests in real estate including –

• Leasehold interests of 30 years or more
• Easements
• Rights-of-ways
• Water rights
• Mineral rights
• Royalty rights
• Mineral leases

All of these types of real estate interests are considered like-kind to each other under IRC Section 1031 and may be exchanged for each other.

While the privage letter ruling can not be cited as precedent, and the IRS has the right to rule differently on subsequent occasions, it is a useful ruling for the purpose of demonstrating the IRS's view for similar situations. To receive a copy of the PLR, give us a call at 888-367-1031 or send us a message at 1031@1031cpas.com.

States Begin Regulating 1031 Exchanges

In September, California signed a law that became effective on January 1, 2009 regarding companies facilitating 1031 exchanges. The new law holds Qualified Intermediaries (QI) to new requirements on property exchanges taking place in that state. California wasn't the first - Nevada and Idaho had previously approved legislation on the Qualified Intermediary industry. But, California passed legislation that has the intent to protect consumers while minimizing costly and burdensome regulation to 1031 exchange companies that was sure to be passed on to consumers.

The California 1031 law has become a model of consumer protection for other states, such as Colorado, Arizona and Washington, now considering similar legislation. Some of the requirements include requiring 1031 exchange facilitators to maintain bonding and insurance. They require Qualified Intermediary companies to notify clients of any change in the company's control (as in a sale or other controlling change in management). The California law also requires exchange companies to invest exchange client funds in a way that meets “prudent investor standards”. This last point is, perhaps, the most important measure included. No longer will exchange companies be able to loan funds to affiliates or owners to fund other "investments" (bank-owned Qualified Intermediaries are exempt when depositing funds in bank accounts with a parent bank).

This follows on the heels of a recent industry failures that have affected a significant number of 1031 exchange clients. A couple of high profile cases involve 1031 Tax Group and Southwest 1031 Exchange. LandAmerica Financial Corporation's recent bankruptcy filing (due to LandAmerica Exchange's lack of liquid investments) reiterated the point that additional guidance and regulation was necessary. Exchange intermediaries that are found to have not held the funds in a prudent manner - or otherwise fail to meet the "model law" requirements - could be subject to civil and criminal penalties. It also gives some recourse to injured exchange clients to file a claim against the required bonding, cash deposits, or letters of credit.

States that follow are using the California "model law" as a template for sound, practical legislation that doesn't create undue burden on exchange companies while, at the same time, providing protection to consumers. Each state, most likely, will have their own changes to the model. But the California 1031 law is a welcome trend for ethical, prudent exchange companies and the clients that employ them to facilitate their 1031 exchange tax strategy.