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1031’s R.I.P.

By Tim Berry, JD - Email Editor

Date : May 21, 2008

 

A buddy of mine used to work for a 1031 exchange company. It probably cost him his life savings.  

My buddy talked to an elderly couple and told them about the benefits of a 1031, and asked them to use the company he worked for to do the exchange. They agreed, and the exchange company sold the property for $1.5 million, and the couple went to work finding a replacement property.

A tragic event happened along the way. My buddy’s employer went belly up. . . bankrupt. . . kaput.

No problem, everyone thought; the elderly couple’s $1.5 million was in a segregated account that would be theirs even if the 1031 company went bankrupt.

Do you think I would be writing this if the money had been protected? Nope. Their $1.5 million, their retirement nest egg, their real estate holdings they built up over their lives, has pretty much disappeared into thin air to support all the attorneys’ billing on the company’s bankruptcy case.

Think of the havoc this has just wreaked upon the lives involved.

The elderly couple are now financially devastated. This was the asset that was going to support them for the rest of their lives. This was the inheritance they wanted to pass down to the kids and the grandkids. Now it’s a massive liability.

How did this turn into a liability? Think about it. Since the $1.5 million has disappeared, they no longer have that money to reinvest in real estate. Since they aren’t going to reinvest in real estate, that means they aren’t going to be able to meet the requirements of section 1031. Since they can’t meet the requirements of section 1031, that means they aren’t going to be able to defer taxes on about $1 million dollars of gain.

They live in the People’s Republic of California. Between federal taxes and taxes owed to the People’s Republic, they are going to have a tax liability of about $250,000 and absolutely nothing to show for it.

My buddy in the meantime is emotionally devastated that he caused such destruction. Not only that, but the couple is now in the process of suing both him and his employer, saying that he should have known that corporate headquarters was experiencing problems. Chances are, he is going to lose his home and savings, all because he talked to a couple about a fairly mundane transaction.

Sure, some of you may be saying that everyone got what they deserved. When you deal with rinky-dink outfits you are going to have to pay the price.

What if I told you that this exact same scenario is playing out with a billion dollar firm--LandAmerica?

At one point, LandAmerica, along with four other companies, controlled 93% of the $14 billion dollar title insurance market. You would think nothing bad could happen with them, wouldn’t you? You would think that a company that large would have their paperwork correct, wouldn’t you? In short, you would think that you would be safe using a billion dollar entity to do a relatively simple tax transaction, wouldn’t you?

You would be wrong.

In November of 2008, LandAmerica declared bankruptcy. At the time, about 450 people were running 1031 exchanges through their 1031 entity. The total value of those exchanges was close to half a billion dollars. LandAmerica was holding on to $450 million in client’s assets to facilitate tax-free exchanges. $450 million!

Since LandAmerica was a billion dollar company, and LandAmerica put their client’s interests first, some of the $450 million was held in separate, segregated accounts. Here’s the rub. Recently a bankruptcy judge decided it was irrelevant if the accounts were segregated. The judge decided the $450 million could not be considered client’s funds; instead the $450 million was to be considered LandAmerica’s assets.

The clients would now simply become creditors of LandAmerica.

In the meantime, one source estimates attorneys are billing about $100K a day. I don’t think there is going to be much left of this bankruptcy estate to compensate the victims.

About 450 financial lives have just been devastated.

Just imagine how you would feel if your retirement nest egg you had built up over the years vanished simply because some company didn’t have the right paperwork.

The moral of the story: If you are going to enter into a 1031 exchange, don’t just use a facilitator, accommodator, or whatever titles a company wants to go by. Make sure your funds are held in a trust. Under the tax code regulations, instead of using an accommodator you can use a qualified trust. DON’T USE AN ACCOMMODATOR who puts your funds in a general account or segregated accounts.

Also, investigate some of the other tax planning tools available to you, such as structured sales and charitable remainder trusts. While you might have heard of them, you probably don’t know how to properly utilize them for your benefit.

If you would like the actual court documents/briefs, summarizing the positions of both the bankruptcy trustee as well as the owner's of the properties, email info@trustmakers.com. We are going to be launching a new executive level service. We are going to create a back room data base of what we feel are "cutting edge", important court cases dealing with Asset Protection topics. We are big believers in the idea that "sunlight is the best disenfectent" and so not only are we going to make the court cases available to you, but we are also going to have the briefs and actual documents being litigated available as well. In many cases these are going to be documents that people have paid thousands, if not tens of thousands of dollars to have created. We will also be offering a subscription service for a small fee. Let us know if you have an interest, just email info@trustmakers.com an let us know. Before you know it, you will have an insider's viewpoint on these strategic cases.

By Tim Berry, JD
TrustMakers.com

 

 

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