While a 1031 Tax Exchange can be the best friend to a real estate investor, its current state is very murky right now. A 1031 tax exchange is a tax code section that allows real estate investors to sell property and purchase replacement property of equal value and defer all the taxes on the sale assuming some simple rules are followed. The triple whammy hit the 1031 Industry in summer of 2007 with the slowdown in the economy and the gauntlet fell in fall 2008 when business almost shut off. The triple whammy is depreciating prices, lack of capital for new investment property and dramatic decrease in sales. As a 13 year practitioner of 1031 exchanges, the 1031 industry should be downright embarrassed of the image it has portrayed. Over that last 2 years at least 10 exchange companies I know of have lost or spent client's funds. Basically the principals of these companies lost the cash and trust of their clients by not prudently placing the client's cash in secure cash investments with modest returns. One of these companies, lost over $150 million dollars of client escrow money. Even as the industry puts more regulations into place, there have been 3 losses in the last months, 2 involved theft of funds and one involved poor choice of placement of the cash in various investments chosen by the Qualified Intermediary. The reason why most of this money was lost was because decision makers at these QI firms got greedy and invested the client cash in non guaranteed funds looking for higher returns than basic money markets. While I might sound harsh but my point is that it was not the QIs money and they had no right to not place it in a standard money market.
While I did not write this article with the purpose of telling you how to choose a qualified intermediary, please ask one question when choosing a QI, where is the money held and who has control of the money. If a QI company will not let you chose where to place the money or make sure you authorize all transfers, I would question them. They might charge you more to place the money in your bank but it may be worth extra fee. In all honesty, I would bet ¾ o our clients do ask us where the money is held.
A recent statistic by the Small Business and Taxation Commission estimated the 1031 exchanges will decrease by 80% annually over the next 5 years. I would agree based on discussion among my peers in the industry, business is down almost 90% for many. Many can QIs may say that business is not that bad but I think they either have a great referral source or are pulling our legs. The small boutique 1031 shops either offer another service to survive or have left the industry. I know many former 1031 exchange agents.
The IRS pronouncement that I think hurt the 1031 industry was Revenue Procedure 2008-16. It was a quiet change. This Rev Proc issued guidance on when 1031 exchanges could be performed on vacation homes. Since there was no guidance before this Rev Proc, I believe the interpretation of vacation homes eligibility was much more liberal than after the ruling. I am convinced the number of vacation homes exchanges has dropped dramatically. This revenue procedure is not law but guidance from the IRS. Finally there is a tax law provision allows certain individuals with income under $50,000 to pay zero cap gains, why would you do and exchange if you don't owe any tax. Nothing is going in the industries favor.
While we will continue to perform exchanges until the real estate market improves. We are lucky because we do have another service that is growing. Unfortunately for all investors Capital Gains tax rates will go up some amount in the near future but this maybe the saving grace that brings the 1031 industry back to life.
Dave Owens is the President of Entrust 1031 Exchange a firm that specializes in Self Directed IRAs and 1031 Exchanges. He can be reached at dave.owens@1031-ira.com or 239.333.1031 x203.
Dave Owens, CPA, CES®
Managing Member
1520 Royal Palm Sq Blvd #320
Fort Myers, FL 33919
239.333.1031 x203
239.466.5496 Fax
www.AdvantaTrust.com
PS - Download your free copy of my new eBook on Real Estate IRAs at www.daveowens.com.
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Happy '09 - IHLLC