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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, May 28, 2007

WSJ: Financial Problems of Qualified Intermediaries May Bring More Regulation of 1031 Like-Kind Exchanges

Interesting article in the Weekend Wall Street Journal:  Tax Strategy For Real Estate Hits Rocky Turf; "QI" Ploy Draws Focus as Middlemen Develop Financial Difficulties, by Peter Lattman & Kemba Dunham:

A popular tax-deferral trick for real-estate investors is facing scrutiny as key middlemen in the strategy run into financial trouble. The problems are starting to leave investors with significant losses, and raising the possibility of increased oversight of a lightly regulated corner of the real-estate investment world. In at least one instance, a firm that helps investors defer taxes this way is facing allegations of fraud.

The strategy, known as a 1031 exchange, lets investors who sell investment properties defer capital-gains taxes if they invest the proceeds in "like kind" property within 180 days. To qualify for the benefit, the seller can't touch the money from the sale. Instead, the funds must go into an account until they are used for the purchase of a new property. That's where the money can be vulnerable.

These exchanges have been around for nearly 90 years, but their popularity has increased in the past decade as the number of real-estate investors has exploded. In a 2005 study by Deloitte Tax LLP there were about 220 million 1031 exchange transactions in 2003 totaling about $200 billion in value, the most recent data available.

The accounts for 1031 exchanges are typically handled by a party called a "qualified intermediary," also called an accommodator or facilitator. While many so-called QIs are part of banks or title-insurance companies, the QI business is largely unregulated. There are hundreds of independent QI businesses across the country. Furthermore, a QI can do virtually anything with the funds in its possession, subject to its agreement with the taxpayer. "There isn't any kind of prohibition in the tax code that says where those dollars can be placed," says John King, senior vice president at a subsidiary of Fidelity National Financial Inc. in Jacksonville, Fla. that serves as a qualified intermediary. ...

The past several months have seen at least two big cases of independent QIs running into trouble. [See TaxProf coverage here.]  Clarissa Potter, deputy chief counsel of the IRS, says the agency is following the trouble. "We know taxpayers may face disruptions when an intermediary cannot meet its obligations," she says.

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Something is wrong. 200 billion for 220 million?

That averages out to $900 each.

Posted by: Justin | May 28, 2007 2:53:21 PM