The Housing Chronicles Blog: Beware your 1031 Exchange provider

Thursday, December 4, 2008

Beware your 1031 Exchange provider

In theory, one great way to postpone paying taxes on the sale of investment property is to buy and sell through a 1031 Exchange, but there are some time restrictions and everything has to be done through a third-party intermediary. So what happens when that third-party goes bust? Clients of LandAmerica are now finding out. From a Wall Street Journal story:

The collapse of title-insurance company LandAmerica Financial Group Inc. has left hundreds of real-estate investors scrambling to recover money in what was supposed to be a short-term and low-risk arrangement.

The investors, from retirees to a public company, had $400 million on deposit with the LandAmerica subsidiary to take advantage of a real-estate strategy known as a 1031 exchange. A 1031 exchange, named for a section of the U.S. tax code, lets investors delay capital-gains taxes on the proceeds from recently sold property, as long as the investor lets a third party hold the funds. They must reinvest the money in a new property within six months...

The episode is another troubling chapter in the 1031 exchange industry. Earlier this year, a federal grand jury in Virginia indicted Edward Okun, operator of 1031 Tax Group, for allegedly plundering $132 million of client money as a "qualified intermediary," the same role played by LandAmerica. Mr. Okun pleaded not guilty. His trial is set for 2009.

Separately, DBSI Inc., a Boise, Idaho, facilitator of tenant-in-common investments that take advantage of 1031 exchanges, filed for bankruptcy in November, plunging 8,500 investors into a legal morass.

In a 1031 exchange, the seller of a property funnels proceeds into an account held by a "qualified intermediary," an entity that holds on to the money in an escrow-like account for as long as 180 days while the seller finds a new property in which to invest. If successful, the investor defers capital-gains taxes on the sale. (The Federal Trade Commission rejected a petition in August 2008 to regulate qualified intermediaries. Only two states, Nevada and California, require qualified intermediaries to meet certain standards.)

Click here for full story.

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