Imagine waking up one morning and getting a call from your bank informing you that for every dollar you had, you now have quarters. In other words, there is only 25% of your cash left. This horrible scenario is now dawning over many former LandAmerica 1031 exchange customers and they may have little choice but to accept.

Close to 350 former LandAmerica customers had until November 10 to vote on a plan which would have split the proceeds of a bankruptcy ruling according to the type of 1031 exchange agreement they had in place (A U.S. trustee has filed an objection to the ruling which has delayed proceedings). Customers who set up non-segregated plans would have received only $0.25 for every dollar held, those with segregated accounts would have received $0.70, and those who specified their funds be held in an escrow account would have received $0.97.   

The reason this tragedy came about was that those customers in LandAmerica without segregated accounts essentially had their money commingled with other customers' exchange assets. This cash was then used for investment purposes, in this case, auction rate securities which eventually were frozen. As unimaginable as it may seem, this sort of account process is commonplace among many large corporations who facilitate 1031 exchanges. Once your money is handed to them, unless you have asked the question or direct the QI yourself, your cash is dumped into the communal pool of assets. More importantly, you have the worry that the exchange group does not have any knowledge of where the money is held. Your money may be wired to "Treasury Services" such as what happened at LandAmerica.

What has emerged from this case is that you can obtain the same protection for you assets by having the appropriate contract language in place and making sure your proceeds are in separately identified accounts (which ES Group uses 100% of the time). Had this been done, LandAmerica customers would have been able to obtain higher recoveries. Of course, hindsight is always 20/20 and this provides little consolation to those who have seen their wealth disappear. Cases like LandAmerica demonstrate who you do business with and how you do it, is of paramount importance.

At Exchange Solutions Group, we have always ensured our customers' investments were safe through allowing customers to identify their own bank in which their money will be held. Though it may seem obvious, this option is not available at most other 1031 exchange corporations. By allowing customers to choose their own bank we allow them to introduce a third party (a banker) who is separate from the exchange and can ensure their investments are alone in a separately identified account. The essence of the 1031 exchange is to defer capital gains taxes and continue your investment; this becomes a failed strategy if it's derailed by poor corporate decision making, or alternatively not knowing what pitfalls to lookout for!

In a recent survey of the laws, practices and size of inflows in 60 jurisdictions, Delaware was found to be the "most secretive financial destination". Coming after Delaware were: Luxembourg, Switzerland, the Cayman Islands and the United Kingdom. These findings may strike some as odd due to the well known reputation of the other front runners but upon closer look, what better secret destination could there be than a state few people bother to notice?

In 2007 the U.S., led by Delaware, received $2.6 trillion in deposits from non-resident individuals and corporations. Delaware draws such attention due to its investor friendly laws which give businesses opportunities they cannot find elsewhere. For instance, Delaware does not tax profits realized outside the state or require that companies be physically present. Furthermore, there is no state sales tax or corporate tax, one person may be the only stock holder and hold all executive offices of the corporation and officer names do not need to be listed on the articles on incorporation. Delaware also boasts a uniquely specialized corporate court system known as the Delaware Court of Chancery which uses judges who have expertise in corporate law instead of juries. All told, there are about 700,000 entities active and registered in Delaware, among which nearly half are publicly traded. UBS and Credit Suisse alone have about 200 entities in the state.

Besides 1^st year law students, many LLC's or small businesses don't concern themselves with have their "corporate veils" pierced. However, much of Delaware's traffic is driven by their respect for the LLC entity as an independent driving force from the people behind the company. When analyzing potential liability, business owners are always looking to mitigate risk.

The Senate is considering a proposition that will both extend a popular tax credit for first-time home buyers past the previous Nov. 30 deadline and expand it to include certain current homeowners. This development has implications which directly affect the market for 1031 like-kind exchanges, as it will propel home purchases, allowing many investors to exchange their rental properties in a 1031 exchange.

So far, ES Group has already facilitated three of these exchanges this week. The reasons for exchange have been somewhat varied. In two cases the owner simply exchanged their previous residential rental property for another, often times with a more desirable location, such as a rental property closer to a daughters college or in a potential ideal retirement community. In the other case, the owner was simply tired of running an active investment and decided to enter into a tenant-in-common syndicated commercial real estate investment (TIC). Either way, the tax credit is having an affect on those interested in utilizing the 1031 exchange.

With the tax credits extension, it seems only logical that there will continue to be an upswing of 1031's in this area. Especially since residential values have been faring better recently, recovering from their precipitous decline. The economy, though posting a positive GDP in the latest quarter, remains in an economic quagmire with unemployment still high and showing little signs of lessening in the near future. Thus, selling now to people incentivized by tax credits could be less risky than waiting for opportunities during a "jobless recovery". These government incentives will not continue forever and investors need to constantly keep an eye on where they would like to end up.   

If untouched, capital gains rates will automatically revert to 20% on December 31, 2010. Currently the rate stands at 15% and if the Obama Administration makes good on earlier indications, the rate could be raised even higher to 28%.

With capital gains rates set to increase, it only makes sense that more people will want to defer their impending tax burdens by transferring their wealth through 1031 exchanges. Furthermore, it could be possible that the Net Lease market segment will benefit greatly from this.

Net Lease Investments, which are characterized by their long term stability and hands off managerial approach (functioning like a bond), could afford people an opportunity to avoid their large capital gains hit while retaining a revenue producing asset which requires no personal management.

Instead of selling ones $1 million asset and bearing a $200,000 to $280,000 loss through capital gains taxes, you could exchange that asset for a net lease building, defer taxes, and get a monthly income stream.

Timothy Harris, an estate planning attorney and founder of Timcor Exchange, passed away two weeks ago after his battle with cancer ended. He was known throughout his profession as a trailblazer and as one insider commented; "a pioneer for all independent exchange companies". 
 
Timothy Harris will be remembered by the many he inspired and missed by all he knew.

I recently ran into a very interesting blog by Net Lease Insider on the benefits of the 1031 Reverse Exchange. They interviewed Stan Freeman, President of Exchange Strategies Corporation and he provided some useful insights:

1. You can extend the time limits of your 1031 reverse exchange above 180 days because you are dealing with multiple properties, each with their own schedule.

2. You can actually make enough money from the exchange to offset the fees for completing it. If the properties you own are both producing cash flows, you are still privy to the revenues from them while waiting for the exchange's completion.

There is more detailed information within the Net Lease Insiders post; those who are interested in 1031 exchanges will find the piece very interesting.    

When someone mentions Watergate, I instinctively think of the Nixon scandal and how that event highlighted and even symbolized the problems our country faced. Government was not to be trusted and our leaders were, contrary to their protests, crooks. Even though the event itself was relatively minor and as the subsequent 1972 election results proved, completely unnecessary, it was a microcosm of all that ailed the nation.

Today I read another story about Watergate, this one about how the hotel part of that complex is about to be sold for around $40 million after its previous owner, "an affiliate of Monument Realty, a Washington D.C. developer, and an affiliate of Lehman Brothers Holdings inc." defaulted on their $43 million dollar loan. They had planned to redevelop the property "into a boutique hotel with some condominium units". This story seems to feature all the major players of our current crisis: defaulting loans, foreclosure auctions, and of course Lehman Brothers.

The tale seems all too common and unfortunate, a group over leverages itself on a loan for a building, attempts to redevelop it, then defaults as the credit crises hits. Except here it takes place in our nation's capitol, with regard to an iconic building, which at one point in time was the symbol of high end property. It is an amazing microcosm, reflecting the fall from grace that has befallen our real estate industry. One has to wonder at how a singular building can find itself mirroring the woes of a country so perfectly on two separate occasions.

Recently, I have been searching for an automobile to replace my current 1990 Volvo Station Wagon. When I speak to people about this search I often hear about how "this is a great time to buy a car", the economy is terrible and buyer power is at an all time high. Operating under this assumption, I made multiple visits to various auto dealers, assuming each time a great deal awaited me. But to my surprise and utter frustration, the fabled deals did not exist. Instead I encountered four letters which I thought would be of no value in this climate: MSRP.

In an economy where GDP is shrinking and unemployment is going up, how could MSRP possibly matter? As far as I understood, "MSRP world" went away about 2 years ago and we are now living in something called "discount world". But this fact did not resonate with dealers; they were intent on getting close to their MSRP value.

When I mentioned this to a co-worker, he exclaimed that the same thing was currently hampering commercial real estate. Buyers and sellers were living on different planets, each with their own set of prices. For proof you can check out this report from CA Real Estate Journal. The divide between the two is eerily reminiscent of those middle school dance scenes we see in movies, where the boy and girls stand on opposite sides of the room, each waiting for the other side to come to them. Likewise, you can imagine buyers and sellers standing on opposite sides of a room, nervously eyeing each other, looking for some sign or signal that the other side may be willing to close the gap and concede to their price point.     

Of course in the movies eventually some bold individual breaks the ice, causing a chain reaction whereby both sides meet nicely in the middle. So when will that happen for commercial real estate? When will we find common ground? Well of course if we knew that, there would be no issue, our situation would be resolved. As it is, we must linger in uncertainty, standing on opposite sides of the price spectrum, waiting for that mutual resolution. Until then, I'll just keep low-balling dealers.  

Like it or not, we could be locked in between two forces heading towards each other at breakneck speed, our fates depending on which one reaches us first. In one corner we have the economy, a once seemingly unassailable force of nature, now hobbled by recession and slowly trying to recover. In the other corner there looms billions of dollars worth of commercial real estate loans, quietly waiting as the seconds tick off towards their maturity date. We stand in the middle, our fates tied to the outcome of this race. 

If the economy recovers before the proverbial time bomb of CRE loans detonates, we should be fine. In the next five years, nearly half of all commercial real estate loans mature, Deutsche bank predicts that around 65% of these will not qualify for refinancing. This could represent either a large opportunity or threat, depending on our state of affairs. If the economy has recovered, unemployment is down, credit is flowing and consumers are spending, the glut of properties available to the market should be eagerly grabbed by buyers.

However, if there has been little or no recovery, there is a good chance those properties will lay vacant, property values will drop and banks will be flooded with assets taking a loss. Already there is dire news, July saw a 5.1% drop in the commercial property price indices, marking a 39% fall from its October 2007 high. Furthermore, according to Real Capital Analytics, the number of commercial property sales which are classified as "troubled" (properties in default or close to it) almost doubled to 23%  in July from March. Total commercial real estate sales through July of this year have been about 1/3^rd of those last year. There has been positive news as well, as Fitch Ratings reports the credit outlook for retailers has improved over the course of 2009.

We know the economy will improve but as with all things, timing is everything. 2012 marks the year most of these loans come due, by then the economy is projected to have mostly recovered. If that is the case, then disaster will probably be averted and 2012 could mark a period of substantial growth and recovery. If not, 2012 could be remembered as an ugly cliff from which we had a nasty fall.  

We often hear talk of the "hidden pleasures" of life, the little things, like enjoying the Sunday paper or catching the fleeting glimpses of a sunset. And as everything seems to have an inverse in this world, there are also "hidden antagonisms" of life, little nondescript and unapparent tortures which spring upon us at our most misfortunate position. Often they come in unassuming yet ominous forms, as is the case of one particularly devilish horror: Form 505 or The Maryland Nonresident Income Tax Return.

Its full name should give some clue as to the nature and power of the Demon, this is no lesser creature; it comes fully charged with the powers and relentless malevolence of a tax collector. However, its most insidious characteristic is one which we are at fault for: the ignorance of its existence. And this is one situation where ignorance has a steep price.

The scheme behind it is simple enough: anyone who has an investment in Maryland, such as a rental property or a sole proprietorship, should be taxed at Maryland's exorbitant rates, regardless of whether they live there. The taxpayer is usually not warned that they must file anything and years can pass before they ever find out that they needed to file a MD form 505.  If you work with a certified public accountant (CPA) he/she should pick up on this and advise the tax payer of their liability if there is one.   Since this is common, Maryland can work with the taxpayer to file past returns and keep them in compliance.

For Example, consider this fact set:

Say you owned a rental property in Maryland from 2003 to the present while you held residence in Virginia. Today you have a net of $380k on the property which at 7% makes the Capital Gains tax $26.6k. Also, let's say you earned $35.2k in income from the rental property which you paid taxes on in Virginia and you never filed a Form 505.

Today if you tried to dispose of the property you would be responsible for the cap gains tax of $26.6k, all the back taxes never paid on the $35.2k in income (regardless of the fact you already paid them to Virginia) and subsequent penalties for not filing Form 505. Clearly, an investor's paradise. 

Again, talking to your CPA is important to find out how to work with the state that you never filed the nonresident return. Most of the time, if you filed the non resident return and paid the taxes accordingly, you can offset resident tax liability as a credit from the nonresident tax liability you have to pay. So going back to this example, if the tax payer would have to pay the nonresident tax to Maryland, he/she could have taken an offsetting credit up to the amount he/she paid taxes to Maryland on his/her Virginia resident return. This helps avoid double taxation.  Since each state has different tax rates, the credit may not be dollar for dollar of the taxes paid to the non resident state.

The Solution?

If you are going to invest in rental property or a business that is not in your state, consider speaking to your CPA or lawyer if there will be a nonresident state tax or other requirement for that state.