Articles

So far in 2007, there have been three spectacular 1031 intermediary defalcations: Southwest Exchange of Henderson, Nevada ($100 million), Scoop Daniel of Breckenridge (the attorney that took one million and disappeared), and IXG (locally) and its related companies ($150 million).

All of these problems arise from two systemic problems with the industry: first of all there are no entry barriers to become an intermediary. Both Southwest and IXG were existing intermediary companies that were purchased by people who had no intermediary experience and whose sole intention for purchasing the company, apparently, was to get control of the exchange balance. Locally, Mile High Capital from last year is another example of this problem because according to several press reports they set up their own intermediary company and hired a convicted felon to run it.

Around the end of most years I write a column predicting what you are likely to see in the 1031 arena over the following 12 months. I recently spent an afternoon in a meeting with one of the people responsible for Section 1031 of the tax code for the IRS. Based on that meeting, what follows are my predictions of changes to look for during the next year.

Tightening of the requirements for qualified intermediaries -The IRS knows that they have problems with what they call “Accom-modating Accommodators.” These people are qualified intermediaries (QI) who are pretty loose with the requirements of a 1031 exchange. The problems range from these QIs regularly allowing clients to do 1031 exchanges on fix-and-flips, to their allowing clients to change their identification letter after the 45th day. The IRS knows they are out there, but it is not always easy for them to tell who these intermediaries are.

One of the critical requirements for a 1031 exchange is the same taxpayer must hold title to both the Old and New Properties in the exchange. While the exact amount of time these properties must be held is not defined by the IRS, it is clear that it has to be the same taxpayer, and both properties must be held for investment.

If Fred and Sue, for example, own an apartment building they are selling as joint tenants, and buy a replacement property for their exchange as joint tenants, then clearly the exchange involved the same taxpayers since Fred and Sue were on title for both the Old and New Properties. But what if Fred and Sue wish to protect themselves by putting the New Property into an LLC as soon as they acquire it? Most attorneys would say that was a smart business decision and quickly set up the LLC for them.

...if you have control over a transaction . . . the IRS could view your transaction as a violation...

The “Contract Question” provides more questions than answers...

In certain areas of the country, real estate prices have been skyrocketing. It is not uncommon to see properties double in price over the course of a year -- even before the builder has completed construction! This phenomena has created a situation we are seeing more and more in the 1031 exchange business. Many investors are getting property under contract (pre-construction) and selling that contract prior to closing on the purchase at a substantial profit. In this situation, can they perform 1031 exchange?

As an example, Ivan Investor sees a new condominium development planned for completion in about a year and a half. Ivan plans to buy a unit and rent it out once it is completed. So, Ivan gets a unit under contract for a purchase price of $300,00