INSIST on a Segregated 1031 Exchange Account

There is a very good article on Summit 1031 Exchange in the Bend Bulletin Friday, February 14th edition. We've previously spoken about firms that held themselves out as Qualified Intermediaries who didn't disclose or have misrepresented where investor client money was held. We've also spoken about industry-led legislation - both at the state and national level - trying to curtail the irresponsible practice of "investing" escrowed funds in anything but completely safe, liquid accounts. Intermediaries that hold investment funds in anything outside of cash equivalent, segregated bank accounts, in any prudent investor's opinion, are simply playing games with your money.

1031 Corporation has always held each exchange client's funds in a segregated bank account at our FDIC-insured parent company, FirstBank. FirstBank is participating in the FDIC’s Transaction Account Guarantee Program. Under that program, through June 30, 2010, all noninterest-bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. While most banks can only insure up to $250,000 of your money through the FDIC, FirstBank's 25 separate charters also make it possible for your interest-bearing 1031 proceeds to be insured up to $6.25 M.

Many Qualified Intermediaries will talk about the amount of 1031 Corporation fidelity bonding they have (1031 Corporation has $25 M). However, most don't discuss that bonding typically involves theft of an employee or officer and covers the FIRM, not the client. While this gives added financial capacity for a company to recover any lossed money, a firm that exceeds this loss or is unwilling, or unable, to honor their contractual obligation to the client has to be sued. In the cases of convict Ed Okun's 1031 Tax Group and LandAmerica Exchange Co, losses far exceeded the bonding - forcing the company into bankruptcy. It is then up to a bankruptcy court to allocate the recovery of funds. As we saw in the LandAmerica case, significantly greater weight in that allocation came from the clients that had insisted on segregated accounts. Of course, had LandAmerica held all accounts in segregated bank accounts, rather than the Auction Rate Securities (ARS) market, those losses probably wouldn't have occured in the first place.

Like any other company you do business with, you should check out and be comfortable dealing with that company. Whether it's a bank you deposit your money in, an insurance provider you buy coverage from, or a retailer you buy goods at, you should always be confident that you are making the best decision before you do business with them. Reputation, financial capacity to honor claims and their ability to perform to your satisfaction are of utmost importance. In completing a 1031 exchange, I, personally, wouldn't have my QI hold my proceeds in anything but a liquid bank account. You should insist on the same!

Arizona introduces 1031 exchange legislation

The State of Arizona, following the lead of many other western states, has introduced a bill to regulate Qualified Intermediaries doing business in its state. Senator Thayer Verschoor has introduced Senate Bill 1333 that establishes regulations for exchange facilitators (defined as a person that facilitates an exchange of like-kind property). The bill includes provisions to protect consumers while balancing regulation against common sense allowing ethical Qualified Intermediaries to do business in Arizona.

Similar to laws in California and other, mostly western, states, Exchange facilitators will be required to maintain bonds in an amount of at least $1 million executed by an insurer, deposit at least $1 million in an interest-bearing or money market account (this is higher than other states that have typically required $250,000), or deposit all exchange funds in a qualified escrow account or qualified trust. It also requires QIs to maintain an errors and omissions insurance policy of at least $250,000.

The bill also requires Exchange Facilitators to hold all exchange funds in a manner that provides liquidity and preserves principal and to invest exchange funds in investments that meet the prudent investor standards. The prudent investor rule doesn't specify what instruments Intermediaries must hold funds. Rather, it uses a common sense approach to which investments should be chosen based on their suitability for each escrow account's client. In the case of Qualified Intermediaries entrusted with holding money on a short-term basis, 1031 Corporation has always followed the practice of limiting the funds placed in its trust to individually-segregated, liquid bank accounts.

We applaud Senator Verschoor and Senator Chuck Gray who have lead this sensible approach to legislation. Investors with property in Arizona can be confident that standards of 1031 exchange business practice exist and ethical Qualified Intermediaries in the state can continue to do business without difficult and unpractical regulation.

The Budget, Capital Gains and Politics

A couple weeks back, the Obama Administration submitted its fiscal year 2011 budget outlining the government's plans for tax change. But reports indicate that the timetable for tax hikes may delayed. Some Democratic Congress members are worried that going along with the Obama Administration's increases might cause their re-election bids to fail. So how might this affect capital gains tax in 2010 and beyond?

For joint filers making more than $250,000 (some report this number around $231,000)and single filers making more than $200,000 (including the amount of the gain, keep in mind), Obama has proposed increasing the tax rate to 20% for long-term capital gains (and qualified dividends). The current rate of 15% would be extended for those making less than these amounts.

Nine years later, most have embraced and accepted the policy to tax capital gains and qualified dividend at the same special rate. However, because of this generally accepted principle, there is the possibility that long term capital gains rates may go higher than Obama's 20% proposal. The justification lies in the qualified dividend half of the "same treatment" proposal. If dividends were treated as ordinary income, rates could go as high as 36%. Congress may decide, under the recently enacted Pay-Go rules, that deficit issues and budget scoring require a higher rate. Some have indicated a "blended" same treatement rate of 25% or 28% is a very real possibility.

There is also the potential that November elections will concern enough Congress members to simply extend the Bush tax cuts for another year. Avoiding any action this year would mean the Bush capital gains tax cut would expire at the end of 2010. Many argue (or perhaps justify their lack of action - depending on your political perspective) that now is not the time to raise capital gain tax rates. With the economy in a fragile state of perceived tepid recovery, they should wait to take any action that would raise taxes.

So how do the proposed increases impact your decision to sell investment property? Some time back, we posted a blog about how this tax change may impact your decision to defer the gain through a 1031 exchange. Most would think that paying 15% now sounds a whole lot better than paying 20%, or worse, 25% or 28% some time down the road. But even with tax rates increasing, in many cases, it still may make sense to defer the gain (versus paying 15% tax that is gone today). The answer depends on the marginal increase in taxes, the amount of time you aniticipate holding the asset and your expected cash-on-cash expected rate of return over that period. If you earn a rate of return, and anticipate holding the replacement asset for a length of time, the answer may surprise you. The time value of holding on to that tax money can be powerful!

Discussing your individual situation with your tax advisor is recommended. Of course, you can and/or your tax professional can always contact 1031 Corporation Exchange Professionals for free consultation of your like-kind exchange questions. Even the call is free 888-367-1031.

One of the Most Powerful Tax Deferral Strategies Remaining

"The taxpayer: That's someone who works for the federal government but doesn't have to take the civil service examination."

- Ronald Reagan
As many prepare their 2009 tax return hoping to get a refund, we once again want to remind you how a 1031 Exchange is still one of the most powerful tax deferral strategies remaining available to taxpayers. 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.

The advantage of a 1031 Exchange is the ability of a taxpayer to sell income, investment or business property and replace with like-kind replacement property without having to pay federal income taxes on the transaction. A sale of property and subsequent purchase of a replacement property doesn't work, there must be an Exchange. Section 1031 of the Internal Revenue Code is the basis for tax-deferred exchanges. The IRS issued "safe harbor" Regulations in 1991 which established approved procedures for exchanges under Code Section 1031.

The 1991 "safe harbor" Regulations established procedures which include the use of an Intermediary, direct deeding, the use of qualified escrow accounts for temporary holding of "exchange funds" and other procedures which now have the official blessing of the IRS. Exchanges most often employ the services of an Intermediary with direct deeding.

Anyone involved with advising or counseling real estate investors should know about tax-deferred exchanges, including Realtors, lawyers, accountants, financial planners, tax advisors, escrow and closing agents, and lenders. To learn more about one of the most powerful tax deferral strategies remaining today, please visit our website or call us at 888-367-1031.