Buy Real Estate With Your IRA Or 401(k)

Since it's my birthday (not telling what number!), I thought I'd take the day off from blogging and publish an informative piece from one of our business partners. Entrust Arizona specializes in record keeping services for individuals and small business owners who wish to include non-traditional assets within their tax-deferred and tax-free portfolios. The following was provided by Timarie McClendon, director of business development with Entrust Arizona.

It’s a common misconception that the only investments allowed in an IRA or 401(k) is stocks, bonds, and mutual funds. The truth is that broader investment options, including real estate, have been available to the public since 1975. The key is to house your IRA or 401(k) at a company that will allow you to invest in real estate. All real estate investing with your IRA or 401(k) is legal - from single family residences to multi family, raw land, developed land, commercial property and even international real estate.

Self-directed retirement plans have quickly become the talk of the real estate community. Not only are real estate professionals self-directing their own IRA’s into property and projects, they are also using their knowledge about these plans to generate more business.

Don’t be confused by the marketing term “self-directed.” All brokerage firms will offer you their version of self directed. This means you can self directed your money into any of the stocks, bonds or mutual funds they offer. But…..that is where your investment choices end. Finding a truly self-directed administrative firm is not difficult. Some refer to this specific type of IRA as a “Real Estate IRA.” While this is not technically the legal description of a real estate investment within an IRA you can see how this might be the perfect description for the investor who is new to this option.

Understand these real estate investments are just that...investments. The real estate investment must be one that is an “arms-length” transaction. This means that the IRA account holder, as well as certain family members and business associates (disqualified persons), cannot live in a property, rent office space in a property, provide a service, or be involved in transactions in which the IRA buys or sells the property. The critical issue for many is making sure the property remains strictly an investment by avoiding self-dealing or prohibited transactions with family members or business associates. And an investor needs to be aware that all expenses, fees, etc. will have to be paid out of the IRA.

Retirement accounts can partner together in an investment. Utilize the investment power of multiple retirement accounts from people you trust and with whom you may already be doing business. Your IRA or 401(k) can even get a mortgage! You can partner your IRA with a 1031 exchange. You may also partner multiple IRA or 401(k) accounts or even partner personal monies!

You may hear false objections from uninformed advisors such as “that’s illegal”, “it’s too complicated” or “I’ve never heard of that.” Simply put, an IRA is a Trust. It’s that simple. If you understand a Trust, you understand an IRA. To simplify things even further, the IRS code is not written to specifically address what you CAN invest in. It is written to address what you CANNOT invest in. The IRS only prohibits two types of investment transactions - collectibles and life insurance.

You can use your retirement account to invest in real estate and harvest the same tax benefits of the IRA you may currently have invested in the stock market. Self-directed IRA administrative companies function just like your brokerage firms except that they specialize in alternative assets as opposed to securities.

For more information about self-directed IRAs and tax-deferred real estate investing, please take a look at Entrust Arizona's website or give them a call at (480) 306-8404.

Maine Adds 1031 Exchange Intermediary Regulation

The state of Maine recently added it's name to a growing number of states instituting 1031 exchange Qualified Intermediary (QI) regulation. Maine Public Law, Regulation of Exchange Facilitators, was enacted by the Maine Legislature in April and will go into effect on Sept 12, 2009.

The new law utilized much of the language we've seen from a number of western states that have been early in adopting new 1031 regulation. Like other states, the Maine law prohibits commingling of exchange funds with operating funds of the QI, but does not require the segregation of each client exchange account (which we strongly support). The new law prohibits any loans to the QI or affiliated person or entity, and requires that exchange funds be invested in a manner that will ensure liquidity and preservation of the principal. Similar to the recently passed QI bills out west, the Maine law also requires ten day notice of any change in control of the QI.

It does require a lower fidelity bonding and errors and ommissions (E &O) insurance coverage that we've seen in other states. The fidelity bonding threshold is $250,000. The Maine act allows the QI, in lieu of bonding, cash deposits or irrevocable letter of credit in that amount or the use of a qualified trust or escrow account. E&O coverage of $100,000 is required (or in lieu thereof cash deposits or irrevocable letter of credit in that amount).

The Maine law does differ in that it requires annual licensure of any person acting as QI for relinquished property in the state. We've written previously about other state licensure provisions being passed. While licensure may allow the state to keep track of those that are acting as QIs in the state, it does little to protect a consumer against fraud until it is too late.

As we've seen in other failed QI cases, having minimal fidelity bonding and E & O insurance doesn't provide as much security to the client as one would think. Bonding and/or insurance protects the firm, not clients of the QI firm. In addition, each act of fraud is not necessarily considered a "per occurance" event so the bonding may fall considerably short of protecting exchange clients.

While each state has, thus far, adopted segregation of client funds from operating funds, we've yet to see a state adopt segregation of each individual client escrow account. This is a recurring issue in the bankruptcies and subsequent legal procedings that have occured in the 1031 Tax Group and the LandAmerica Exchange cases. Clients of failed QIs that do not segregate - and distinctly identify the segregation of funds in their exchange agreement - will, unfortunately, learn that their interest is pooled together in a bankruptcy case as just another unsecured creditor. Since the funds are commonly "pooled" for greater investment returns, individual client funds are not protected as clearly being 'in trust for' a specific client.

Only segregated accounts and an exchange agreement that clearly makes use of segregation language can ultimately provide protection for clients of Qualified Intermediaries that sell. Of course, due diligence should be performed to make sure you know the financial condition of the QI you chose. Publically available financial statements, forthcoming answers to questions of segregation and investment policy/practices and a solid exchange agreement should all be provided.

If you've interest in discussing provisions of this new state law, or any other pending or passed exchange facilitator regulation, the Federation of Exchange Accommodators is working hard to balance the interests of clients and industry member firms to maximize protection of clients while minimizing the regulatory burden/costs and would be happy to answer many of the questions. We at 1031 Corporation would be happy to answer any questions you might have in selecting a Qualified Intermediary or information specific on how we protect our client funds. Give us a call today at 888-367-1031.

1031 Corporation is Going Green!

Going green is easy with a 1031 exchange. Green as in the Three R's - Reducing, Reusing and Recycling your capital gain tax dollars! The 1031 Exchange option is the perfect “green” way to hold onto your money and reinvest it into another like kind investment. 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.

Through an IRS tax-deferred exchange, you are able to reduce your tax liability. A 1031 exchange provides the ability to defer the capital gains tax with the purchase of like-kind replacement property that would have been due and payable. For a real estate exchange, like-kind replacement property means any improved or unimproved real estate held for income, investment or business use.

Your Qualified Intermediary must hold and forward net proceeds from the sale of your property to the purchase of the replacement property. If you receive cash or have a trade down in value you may have "Boot". Boot is the money received or the debt reduction received by the taxpayer in an exchange. The rule of thumb for avoiding "boot" is to always replace with property of equal or greater value than the relinquished property.

The tax basis of the old property becomes the new tax basis in the replacement property. If you “bought equal,” the basis in the new property is the same as it was on the old property. In a 1031 exchange, the basis rolls forward from the old property to the new property. If your replacement is a trade up in value you will be able to increase your basis by the amount of the trade up. This trade up allows you to increase the amount available to be depreciated.

Just remember the three R's for going green are Reduce, Reuse, Recycle. 1031 Corporation is ready to assist you in Reducing your tax liability, Reusing your proceeds from the sale of your relinquished property on the purchase of your replacement property and Recycling your ability to depreciate by purchasing up in value on the replacement. Are you ready to go green? Give us a call today at 888-367-1031.

FirstBank, 1031 Corporation's Parent, Net Income Up 7%

FirstBank Holding Company, parent of 1031 Corporation, announced first half 2009 earnings grew amid strong loan and customer deposit growth. The bank earned $72.3 million for the first six months of the year. This figure is up 7 percent from the same six-month period in 2008. The company’s earnings per share were up 9 percent from a year ago $556.61.

“FirstBank performed exceptionally well through the first half of 2009, due to our focus on quality loan acquisition, consistent deposit growth and our continued ability to attract new customers,” said President and CEO John Ikard.

Total assets were $9.55 billion on June 30, up 3 percent, and total deposits increased by eleven percent to $8.71 billion. Total loans grew to $4.1 billion - an increase of 14 percent. Return on average shareholder equity was 22.6% annualized for the first six months of 2009.

FirstBank is the largest locally-owned bank in Colorado. The bank operates 121 locations in Colorado, seven in Arizona and five in California and is the parent company of 1031 Corporation Exchange Professionals. It does not originate, hold or purchase subprime mortgage loans or securities, which has helped the company avoid the type of credit losses that have hurt other financial institutions in the past couple of years.

1031 Corporation, a subsidiary of FirstBank, holds each client's exchange funds in a segregated money market account at one of the 25 bank charters. For net exchange proceeds in excess of $250,000, 1031 Corporation can deposit client funds in separate accounts at any of the 25 bank charters FirstBank maintains. This allows 1031 Corporation to provide FDIC insurance of up to $6.25 M per client. For more information on setting up your next exchange, please call us at 888-367-1031.

Subdivided land treated as capital gain

Last month, the tax court ruled on a case (TC Memo. 2009-142) involving the issue of a parcel of land that was subdivided and sold over a period of time. At stake was the issue of whether the taxpayers were required to pay ordinary income on the investment property versus being treated to a more preferential capital gains treatment. It has implications for those considering a 1031 exchange that face a similar issue.

The case involved a couple that had purchased a 14 acre parcel to build their primary residence. Prior to building, the couple decided they would prefer to have neighbors rather than being so remote. They made the decision to subdivide the former agricultural property into ten parcels.

Over the next four years, the couple went thru the re-zoning process, created a homeowners association and sold seven of the lots. When the couple reported the income as capital gain, the IRS claimed that, with the sale of multiple lots, their status had changed from investor to dealer and that all profit constituted ordinary income due.

Eseentially, because a) their advertising was nothing much more than a simple wooden sign, b) they sold the lots primarily to acquaintances and c) they were not considered real estate developers (having ownership in a non-development, successful business), the tax court held that the gain qualified for capital gains treatment.

The case provides insight with respect to 1031 exchanges as well. It, theoretically, follows that if the taxpayer had chosen to exchange into another qualifying real estate investment - rather than simply sell the lots and pay the capital gains tax - they could have deferred the gain under section 1031.

We are occasionally asked what qualifies as "held for" investment and what type of exchange does not qualify due to the taxpayer being viewed as a dealer (i.e. - developer) versus an investor.

The court laid out nine factors that determined the property status:

1. The taxpayer's purpose and reason for property acquisition.
2. The purpose for subsequently holding the property.
3. The taxpayer's everyday business.
4. The frequency and substantially of sales.
5. The extent of improvements.
6. The extensive use of advertising.
7. The existence of a business office for property sales.
8. The degree of supervision over sales agents.
9. The time habitually devoted to sales.

It would appear that a taxpayer that can meet the above factors, and considering a like kind exchange, could reasonably justify they are not a developer/dealer and qualify for deferred treatment under section 1031. While each case is different (and as we caution - the specific circumstances should be reviewed with a tax professional before proceeding), the case does provide some important insight into what might be possible.

Have a similar issue involving a 1031 exchange? Give 1031 Corporation a call at 888-367-1031. The phone call and conversation are free.

Is your Qualified Intermediary an FEA member?

Do you really know the structure and background of the company with whom you are placing your 1031 exchange proceeds? In the tough economy, that all of us are facing, is your Qualified Intermediary (QI) looking out for your best interests?

1031 Corporation has been active in the QI business for 19 years. We are a member of the Federation of Exchange Accommodators (FEA). FEA is the only national trade association that represents like kind exchange professionals. Established in 1989, the FEA was organized to promote the discussion of ideas and innovations in the industry, to establish and promote ethical standards of conduct, to offer education to its members, and to work toward the development of uniformity of practice and terminology within the exchange profession. Professionals that are members of this association enjoy membership benefits that include:

· Legislative and regulatory updates regarding the 1031 industry

· Educational conferences

· Enhanced professional credibility

· Only FEA Members are eligible to earn the distinguished Certified Exchange Specialist® designation

· Access to fidelity bonding and errors and omissions (E&O) insurance

As exchange professionals, 1031 Corporation offers the advantage of being a FEA member to our clients. Currently there are only 208 Company and Individual members in the FEA association. Is your Qualified Intermediary one of them?

IRS Considering Relief for Taxpayers Caught Up With Bankrupt QIs

Large and small 1031 Exchange Qualified Intermediaries (QIs) have gone into bankruptcy in the last couple of years for a variety of reasons, including frozen liquidity in the financial markets and questionable diversion of exchange funds to fund loans to related companies. This has caused taxpayers to not only lose their 1031 exchange funds but to also have income tax liabilities for incomplete replacements under §1031 for the sale of their real estate.

Congressmen and Senators have been receiving complaints from their constituents for some kind of tax relief in these circumstances and the IRS has been receiving appeals to do something about this. As a result, the Internal Revenue Service is notifying Congressmen and Senators that it is working on some kind of relief for taxpayers who have been unable to timely complete a like-kind exchange because the used a Qualified Intermediary that went bankrupt.

Up to now, the position of the IRS has been that a sale of property is taxable if the 1031 Exchange fails due to a bankrupt QI with no taxpayer relief.

The IRS has also said that if a taxpayer sustains a loss of exchange funds due to a bankrupt QI that is not compensated for by insurance or otherwise, he can deduct the loss from gross income under Code Section 165(a), but only in the year the loss was sustained. Sometimes the loss is sustained in the year following the tax year of sale of the relinquished property and is not available for offset of the taxable gain on the sale of the relinquished property.

As a result of all the controversy over bankrupt QIs, the Internal Revenue Service is now saying that it is contemplating some type of relief for affected taxpayers. The IRS has been promising action on this issue since the fall of 2007 when the real estate market started heading south in many areas.

We’ll have to wait and see.