Inn Consultants and Brokers Since 1993

Rick Wolf and Peter Scherman (that’s Rick on the left and Peter on the right) are both experienced speakers who have presented on a range of innkeeping related topics at the state, regional, and national level. They gather and analyze research for the Innkeeping industry and welcome the opportunity to share it with others. Contact Us

The B&B Team
 

1031 Exchange Warning and Advice

1031 Tax Deferred Exchanges are wonderful when they work, but we've just learned of a financial disaster and believe everyone needs to take note.

Simply put, a 1031 Tax Deferred Exchange is a mechanism whereby a real estate investor can roll over the cost basis from one investment property to another and defer paying capital gains taxes until the last property is sold and cashed out. In a transaction, a third party "qualified intermediary" ("QI") holds the funds from a sale until a new purchase is made following strict IRS guidelines. The QI then pays out the funds for the purchase and receives a fee for their services. The problem is, the industry of exchanging is not regulated, and here's what happened to clients of The B&B Team.

They sold their inn. Proceeds of sale went to a qualified intermediary per the rules. They had 45 days to designate new investments and 180 days to settle. After 45 days they hadn't found a property to buy, so they asked for their funds back, only to discover that there was no money! "It seems that he [the QI] invested client funds in Lehman Brothers auction rate securities probably as long as a year ago. When that market froze, he started funding exchanges with new client money (otherwise known as a Ponzi scheme). By the time we were to be funded, there wasn't any cash left."

This is an unmitigated disaster for these folks, and apparently there are a number of exchange companies recently that have filed for bankruptcy, so others have been hurt by similar schemes and problems. But don't throw out the baby with the bath water. There is a solution to protect yourself.

Our client goes on to say, "If someone wants to do a 1031, they need to make sure that the agreement states that their funds are to be kept segregated in an account in their name (very important) and that they specify how the funds are to be invested. In addition, they need to make sure they get copies of the bank statements. If the amount is more than FDIC covers, they might want a surety bond for the difference." To support this, our client adds that "The only one getting their money back so far is someone who did the above. The court ordered an immediate release of their funds."

In a time of greed and uncertainty, there seems to be no shortage of unscrupulous people. But bad behavior doesn't make a system wrong. It's people who are flawed, and people who can learn lessons. We hope you'll make note of this warning and advice about 1031 exchanges, so you can both take advantage of the great tax benefits inherent in them and protect your assets in the process.

Peter

2 Responses to “1031 Exchange Warning and Advice”

  1. Mary McNair says:

    Peter,
    Thanks so much for this information. As we are looking at selling our property, this is something we very well may have considered doing. Thank you for the heads up on ways to protect ourselves.

  2. John Deis says:

    As an attorney with an accounting degree I have never recommended using QI services. Even without this risk they offered a worthless service at a high cost, now this new issue speaks volumes.
    Ask your attorney what the best way to handle this is in your state. In almost all cases your settlement agent, be it attorney, title company or bank can hold your funds in a dedicated, interest bearing account with little or no fees to you and still meet all of the IRS requirements.

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