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.