IRS Provides Relief to Victims of 1031 Intermediary Theft

In the past several years there have been several instances where Colorado 1031 intermediaries either failed or were unable to return the funds they held for their clients.

This had a double-catastrophic impact on the victims because not only did they lose their funds, but they also owed tax on the sale. The IRS has just released a ruling that will help with some of their pain--they can now spread the gain over any cash they recover from the theft.

Some of the losses were small: in 2007 Scoop Daniel, a Breckenridge attorney, disappeared with approximately $1 million of client 1031 funds. Most were large: that same year the owner of the 1031 Tax Group (doing business locally as Investment Exchange Group, or “IXG”), took $150 million of client exchange funds, causing the company to fail. And in 2008, LandAmerica Title Company filed for bankruptcy when its' 1031 division was unable to fund $400 million of client exchanges when securities the fund was invested in became worthless. There have been similar problems with other intermediaries throughout of the country.

To illustrate the typical problem, let’s assume that Fred sold his investment property for $150,000, and on the day of the sale all of the proceeds went to his intermediary. Fred’s tax basis on the property he sold was $50,000. Sometime thereafter, Fred’s exchange funds disappeared and the intermediary filed for bankruptcy.

Under the rules in effect before this ruling, Fred was not only out his exchange proceeds of $150,000, but he also owed tax on $100,000 (the difference between the sale price and his tax basis). With the help of this new ruling (Revenue Procedure 2010-14) Fred now has a taxable gain only to the extent that he ultimately recovers proceeds from the intermediary--either from the bankruptcy court or from the recovery of funds directly from the intermediary.

Every taxpayer’s situation is different, and the ruling contains a number of examples dealing with different things, like situations involving debt paid off at the time of the sale. But the important thing is that if you, or someone you know, got caught up in one of these losses, there is tax relief available for you.

The effective date of the ruling is January 1, 2009--meaning tax returns filed in 2010. But it also allows those taxpayers who were caught up in pre-2009 losses to go back and file an amended return to recover taxes paid in a prior year. This presumably includes all of the major Colorado problems. So, if you were one of those unfortunate people, you should consult with your tax preparer to begin the process of filing an amended return. Assuming that you filed your 2007 tax return by April 15, 2008, you have until April 15th of next year (2011) to get your amended return filed.

Finally, last year (2009) the State of Colorado adopted laws governing 1031 intermediaries that now makes it much less likely that these type of problems could arise in the future..

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