Reverse & Improvement Exchange Financing

Reverse 1031 exchanges involve the purchase of Replacement Property prior to the sale of the property being sold (the Relinquished Property) in a like kind exchange. Since you are not able to own a Replacement Property prior to selling a Relinquished Property, a taxpayer arranges for an Exchange Accommodation Titleholder (EAT) (usually the Qualified Intermediary) to take and hold title to replacement property until they find a buyer for his or her relinquished property.

Reverse Exchanges are also common where a taxpayer wants to acquire a property and construct improvements (an (Improvement Exchange) on it before taking title to the property as replacement property for an exchange. This is necessary if the value of the improvements is important for replacing with property of equal or greater value in order to avoid a taxable “trade-down.”

One question that naturally arises is the financing of the Replacement Property. Since the taxpayer's equity is tied up in the property not yet sold, how does one go about financing the purchase of the Replacement Property? Having the Qualified Intermediary (and EAT) owned by a bank helps....a lot.

See, the trouble is, the property is not in your name yet. So, secondary financing providers have issue with lending to an entity that isn't signing on the loan. If you want to finance 100% of the purchase price and wait to pay the loan down and amortize the loan after your relinquished property sells, most lenders are going to say it is impossible. Further, what happens when the property sells. The proceeds from that sale can't be assigned to the loan since they need to go to the Qualified Intermediary for 1031 exchange purposes.

1031 Corporation has the answers to these questions. As a bank-owned Qualified Intermediary, we can assist with Reverse and Improvement Exchange Financing through FirstBank's 130+ office locations throughout Colorado, Arizona and California. Since we are owned by a bank, we are very familiar with reverse exchange financing issues and can work with our bank officers. Having a Qualified Intermediary subsidiary, the bank officers are familiar with the terms and conditions of Reverse Exchange Financing and can work with you to provide this "bridge" in financing. In fact, FirstBank has a program that allows for long-term commercial financing at the time of Replacement property purchase. They even include a one-time assumption of the loan and waive any prepayment penalty for the Relinquished Property sale proceeds.

Call us today at 888-367-1031 if you are working through the mechanics of Reverse Exchange Financing or if you are having difficulty financing the purchase of your 1031 Exchange Replacement Property. We are uniquely positioned to assist you and would be happy to help expain the process in detail.

Estate Tax 2010

Many older taxpayers work to move wealth they've generated in their lifetimes from one generation to another while minimizing tax liability through estate planning. Intergenerational transfers of wealth have a significant impact on the economy and many believe that the estate tax generates costs to taxpayers, the economy and the environment that far exceed any potential benefits that it might arguably produce. Still, the political landscape today seems to indicate estate taxes are here to stay.

When dealing with estate planning, many older generation taxpayers deed property into a family partnership or LLC. Children receive an ownership percentage "gift" each year that transfers ownership over time. The parents that have acquired the real estate are able to continue to take income from the property but their heirs receive the property without estate tax (up to $1 million in lifetime gift tax exemption). If property is sold, the LLC can utilize a 1031 exchange to sell the investment property and allow the real estate portfolio to grow tax deferred. When the parents pass on, the children then have an ownership in the investment property outside the estate.

If there is not time to do this advance planning, the heirs are subject to an estate tax. This tax had been getting less concerning for many taxpayers due to the Bush tax cuts in 2001 that increased the exemption amount and reduced the tax rate. The tax was set to expire in 2010. It was expected that Congress would re-visit the estate tax before the end of 2009 and put some structure in place. They did not. Because of a limited time circumstance confusion reigns in the current estate tax landscape.

Both the estate tax and the generation-skipping transfer tax (on assets given to grandchildren) were repealed at the end of 2009. If Congress and the President do nothing, both taxes are scheduled to return in 2011 at the unfavorable rates that applied in 2001. The amount that is exempt from each of these taxes will then be $1 million and the tax on the rest will be 55%. Most tax writers do not want this to happen and talks on the estate tax are already underway.

Congress is talking about reinstating the estate tax retroactively to January 1st, 2010 and reviving the "date of death" value for inherited assets. Given the size of some estates, like the one of billionaire Dan Duncan, some are likely to challenge the retroactive imposition of the estate tax and there is a long shot that a proposal gaining ground may give estate a choice in 2010. However, there are past court cases that suggest restoring the tax this way is perfectly legal and could be upheld. Of course, the sooner Congress acts, the fewer number of large estates likely to bring such cases and the less chance these heirs will have to call the tax unconstitutional.

Members of the House of Representatives generally support a proposed $3.5 million exemption and a 45% rate on estates. There is growing support in the Senate for a $5.0 million exemption and a 35% top tax rate. We'll see, in the coming weeks and months, how this plays out and we'll certainly do our best to keep you posted of any news.

By conferring with your tax professional, and utilizing the tools of estate planning and 1031 exchanges together, one can minimize the effects of capital gains taxes on investment property. If you have are considering selling your investment property and want to defer capital gains tax using the tools of a 1031 exchange, please contact the professionals at 1031 Corporation. We have years of experience and work with accounting professionals to structure an exchange to minimize the tax impact on your investment assets. Give us a call today at 888-367-1031.

1031 Regulatory Reform Legislation

Recently the topic of financial regulatory reform has been a hot item in the news. I recently became aware that there is a paper circulating in Washington with a proposed national regulatory bill concerning the Qualified Intermediary industry. The author of this proposal has been running moving around the Capital attempting to put provisions in place that, had they been in place, reportedly would have "prevented the loss of over $770 million of exchangers' funds that has occurred at the hands of QIs which currently operate in an environment that is subject to little or no regulation and oversight at the state level."

Seven states, thus far, have adopted 1031 legislation in an attempt to protect consumers. Those provisions, if adopted by all states, or at the national level, would have, perhaps, prevented or reduced many losses from unscrupulous Qualified Intermediaries. It should be said that, like many laws, people that are crooks will break the law.

One of the provisions that the author of this latest proposal is suggesting, though, is detrimental to the public. It would not allow a bank-owned Qualified Intermediary from depositing the exchange client proceeds into the parent bank. The proposal says that the "depository bank, escrow holder, or trustee holding exchange funds must unrelated to, and independent of, the QI". The pitch is that the bank which owns or controls the QI could then "place its financial interests above those of the exchanger".

This proposal would have the effect of eliminating banks (and their exchange facilitator affiliates) from the exchange facilitator business. This requirement would also negatively impact title insurance company-affiliated exchange facilitators who may wish to use a related escrow or trust company to provide qualified escrow or qualified trust services to provide greater protection to taxpayers.

Despite the fact that banks are already regulated by a state or federal financial regulator (and are subject to more oversight and controls than non-bank exchange facilitators), this proposal seeks to eliminate some of the safest and financially strongest exchange facilitators from the industry. Given that not a single loss has occurred as a result of bank failure, and there has never been any loss of exchange funds that were held in a bank-related QI, there is no history that would warrant this provision.

The national trade association of Qualified Intermediaries, the FEA, has been a strong supporter of federal regulation of its industry to require prudent funds management standards and other protections for its clients. In 2007, the FEA petitioned the FTC for regulatory oversight and submitted to it a comprehensive draft regulation. The FTC denied the petition, saying that the burdens of regulation outweighed the need, and that there was no evidence of pervasive fraud throughout the industry.

The FEA has since been actively involved in passing state legislation to regulate exchange facilitators. The FEA is supportive of legislation or regulations which provide protections for all taxpayers utilizing exchange facilitators and which do not competitively disadvantage any legitimate business model. It is my personal opinion that working with the FEA, and not against its efforts, would best serve the consumer and the industry as a whole.

For the record, 1031 Corporation is owned by FirstBank. We also individually segregate accounts. Please visit our website for a free exchange manual or contact us at 888-367-1031.