1031 exchange firm declares bankruptcy

NEW YORK – May 18, 2007 – The bankruptcy of a national 1031 exchange firm has jeopardized some real estate deals. It’s also highlighted a problem in the like-kind exchange system – a lack of federal oversight on this legal way to shield capital gains from the IRS.

The 1031 Tax Group, LLC (“1031 TG”), a privately held consolidated group of qualified intermediaries for deferred like kind property exchanges, filed for Chapter 11 reorganization in U.S. Bankruptcy Court for the Southern District of New York (case number 07-11448-alg) this week. 1031 TG is a “roll-up” of several intermediaries that offer real property exchanges under Section 1031 of the Internal Revenue Code, including 1031 Advance, Atlantic Exchange Company, Investment Exchange Group (IXG), National Exchange Services, Real Estate Exchange Services (REES) and Security 1031 Services (SOS1031). (Real Estate Exchange Services Inc., a Florida corporation and affiliate of The 1031 Tax Group LLC, is not related to Real Estate Exchange Services Inc. of Marietta, Ga.)

A 1031 exchange, named for its section of the IRS tax code, allows real estate investors to take the  profits from the sale of one property and roll them into another property without paying capital gains taxes. While a number of rules must be followed to make the exchange tax-free in the IRS’s eyes, one important caveat is that the money must be held by a third party between selling and buying. That rule and the complexity of the transaction has created a cottage industry of companies that specialize in 1031 exchange services for commercial transactions.

But investors who parked their money with 1031 TG and its affiliates now cannot access the funds in transition between a sale and a new acquisition, greatly harming some investors financially and making it impossible for real estate brokers to close on signed deals. To add to these investors’ injury, the inability to close within six months could, under IRS rules, also force them to pay capital gains taxes on the money now controlled by bankruptcy courts. For some investors, that money represents their life savings.

According to Pat McCaffrey, a representative of another national 1031 exchange company, Investment Property Exchange Services Inc., the bankruptcy is “a black eye for the industry.” “It’s a non-regulated industry,” says McCaffrey. “Anybody can hang up a shingle in their garage, and people will give them millions of dollars.” McCaffrey says he would “welcome regulation,” but in the meantime recommends that investors don’t just ask a company if it’s bonded, but also “read the bond and see what the bond will pay for.”

Currently, only one state, Nevada, regulates them – but only minimally. “(1031 exchanges) are a niche industry,” says Chris Lee, deputy secretary of state of Nevada. “They’ve flown under the radar for a very, very long time. For the amount of money they handle, it’s amazing that no one is regulating them.”

On its Web site, 1031 TG says it cannot estimate when funds will be released, though it will “prioritize by closing dates and length of time until the 180-day period ends.” However, bankruptcy courts generally don’t disperse funds until the case concludes, a system 1031 TG hopes the court will adjust given the unique nature of the assets.

For more information, visit 1031 TG’s Web site at: http://www.1031taxgroup.com.

© 2007 FLORIDA ASSOCIATION OF REALTORS®

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