What Realtors Should Know About 1031 Exchanges

Realtors are Often the First to Recognize the Potential Benefits of a Section 1031 Exchange to a seller of real estate. When a seller is going to replace qualifying real estate with replacement real estate, a Section 1031 Exchange should be suggested. It is possible for a seller to employ the services of an Exchange Intermediary at any time after a contract is executed up to the day of closing on the contract. It is too late after the closing has occurred.

Accommodation Language in the Contract. Accommodation language is usually placed in the Contract to Buy and Sell Real Estate wherein the other party to the contract is informed and agrees to cooperate with the 1031 exchange. Typical accommodation language might read as follows:

For a Seller - "A material part of the consideration to the seller for selling is that the seller has the option to qualify this transaction as a tax deferred exchange under Section 1031 of the Internal Revenue Code. Purchaser agrees to cooperate in the exchange provided purchaser incurs no additional liability, cost or expense."

For a Buyer - "This offer is conditional upon the seller's cooperation at no cost to allow the purchaser to participate in an exchange under Section 1031 of the Internal Revenue Code at no additional cost or expense. Seller hereby grants buyer permission to assign this Contract to an Intermediary not withstanding any other language to the contrary in this Contract".

Accommodation language is not mandatory and can be omitted if it puts the taxpayer at a disadvantage for other parties to know about his plan to sell and replace property under IRC §1031 and related closing pressures under the exchange 'time clocks."

Assignment of Contracts. If a Realtor knows that a buyer intends to assign the contract to an Intermediary in connection with an exchange, it is helpful to reference the buyer as "John Doe or Assigns" on the contract.

Paragraph 18 of the standard form Contract to Buy and Sell Real Estate used by Colorado Realtors contains a provision wherein the contract is not assignable by a buyer without the seller's permission unless the seller's permission is so indicated with a check in the "'shall' be assignable" box. The standard form Contract does not limit a seller's right to assign the contract.

Another way to make the contract "assignable" is for an addendum to the contract to be prepared by the Realtor making the contract "assignable." An Exchange Addendum to Contract to Buy and Sell Real Estate issued by the Colorado Real Estate Commission containing all necessary accommodation language is also available. Use of this Addendum makes contract accommodation language unnecessary and automatically provides for assignability of a contract by the buyer in an exchange transaction.

Settlement Statements. Section 1031 of the Internal Revenue Code imposes no requirements and provides no guidance with respect to preparation of settlement statements for an exchange of property. The Colorado Real Estate Commission has no special requirements concerning exchanges involving an Intermediary.

Intermediaries often instruct closers to name the Intermediary as the seller of a property on behalf of their client. This is not required by IRC §1031 and creates additional closing burdens since it requires the Intermediary to sign the settlement statements.

An occasional (but unnecessary) practice is for the title company closing on the transaction to prepare a second set of settlement statements in which the Intermediary is shown as a buyer and seller. The Intermediary's set of statements "mirror" each other as to debits and credits. The thinking here is that the settlement statements should reflect a "chain of title." This practice is not required by IRC §1031.

Our recommendation is to prepare one set of settlement statements in the normal manner which total to zero proceeds due to or from the Exchanger. The settlement statements should be made to total to zero proceeds due to or from the Exchanger by showing a debit or credit for "Exchange Funds - 1031 Corporation" as a transaction item "above the bottom line". The amount of "Exchange Funds" is the amount of funds being transferred to or from the Intermediary in connection with the closing.

Call us at 888-367-1031 or email us at 1031@1031cpas.com if we can help with any questions. See our exchange manual and visit us at http://www.1031cpas.com/. 1031 Corporation is the Intermediary of choice for thousands of real estate professionals, CPAs and investors.

Thank You to Our Clients and Friends for Over 20 Years in the 1031 Exchange Business!

Now that we are well into 2011, all of us at 1031 Corporation Exchange Professionals want to express our appreciation for the opportunity we have had over the last 20 years to be of service to our clients and friends.

2010 marked our 20th anniversary as an Exchange Facilitator. Beginning in Boulder County, Colorado we quickly began experiencing an opportunity to work with clients across Colorado and across the country from the east to the west coast. It has been a very gratifying experience for us and we appreciate the confidence our clients and friends across the country have expressed in us and our services.

In 2006, 1031 Corporation became a part of FirstBank of Colorado. With this partnership, clients of 1031 Corporation were able to be assured of the safety of their exchange funds in uncertain times in the industry and economy. FirstBank remains one of the top performing banks in Colorado with over 130 branches in Colorado, Arizona and California and over $10 billion in assets. We are proud to be able to offer such a high level of safety and security to our clients.

The Exchange Industry and related real estate market have seen many ups and downs over the past 20 years and we are currently emerging from one of the worst real estate downturns in recent memory. 2010 showed a steady increase in 1031 transactions and we are optimistic about the prospects for 2011.

At 1031 Corporation we are all dedicated to serving our clients at the highest level of competence and professionalism. Please accept our sincere thanks to all of you and feel free to call us at any time if we can be helpful.

Feel free to visit us and see our exchange manual at 1031cpas.com , or email us at 1031@1031cpas.com.

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.

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.

Recent Quote in Property Swap Regulation Article

Last Friday, an article titled "After Investors Lose Millions, Property Swaps Face Regulation" was released by Investor's Business Daily. Joe Gose, a freelance reporter, contacted some Qualified Intermediaries for comments on the Wall Street Reform and Consumer Protection Act that was approved by the House in December.

As I had previously commented here on the CFPA bill, he contacted me for comments. A previous blog entry I wrote stated some concerns about giving this new "super agency" sweeping and ill-defined powers that mandated who - and what - financial products can be offered to consumers. When Mr. Gose called and left a voice message, it seemed apparent he was intent on a certain "angle". His questioning were clearly fixed on writing an article that painted most of the industry against regulation. Nothing could be further from the truth.

This blog is filled with entries that indicate that I believe some regulation is necessary. I was fortunate to be part of a five FEA member committee that worked to ensure responsible legislation in Colorado. Many other FEA members have worked tirelessly to ensure proper 1031 legislation was passed in Nevada, California, Idaho, Washington, Oregon and Maine. As other states like Arizona consider legislation, the FEA is working with these states. The FEA has also worked diligently with federal officials to determine ways to properly regulate the industry on a national level.

My quoted comment to Mr. Gose was simply that I had concerns about the amendment added late in the game by Representative Michael Michaud (D-Maine). The amendment is brief, it is vague and it essentially places all the power to determine any future national 1031 regulation in the hands of a newly-formed CFPA Director. The bill contains no provision for public input or industry feedback in determining any planned regulation.

I was dissapointed to be incorrectly quoted as President of 1031 Corp and to read that our firm was "hardly clamoring for federal oversight". First, had the writer done some proper research, he would have found that our name is 1031 Corporation. Another Pennsylvania FEA member firm, Joe, is called 1031 Corp. It's also interesting that he picked our firm - one that is owned by a financially-sound bank, holds investor client funds in a segregated bank account, maintains a $25 M fidelity bond and is audited and regulated already by the FDIC, external and internal auditors - as somehow against consumer protection.

So, what's the reason/motivation for the incorrect quotes, Joe?