When it comes to 1031 Exchanges, beware. Do you know who has been entrusted with your money? A recent report in the Wall Street Journal article highlighted a rash of 1031 exchanges companys that have stolen investors’ funds and used them to fund an expensive lifestyle.

1031s Loosely Defined: Thousands of real estate investors have used 1031 exchanges to defer capital gains and other taxes due when buying replacement investment property. When the rules are properly followed, a 1031 exchange — also referred to as a Starker trust or Starker exchange — allows a real estate investor to buy and sell real estate without having to pay any federal income taxes on the sale of the property. The payment of any taxes is deferred until the owner of the property dies or sells the property and does not use a 1031 exchange.

The problem is that 1031 exchange companies are unregulated, and security is not high on their list of priorities. Making sure that investors’ 1031 funds are secure is expensive and time-consuming. So a lot of 1031 exchange companies don’t do it.

In the past few months, the faltering economy and slowing real estate market have meant trouble for many 1031 exchange companies that aren’t quite on the up and up. But the sheer magnitude of some of the ponzi cases, is startling. 

•  In Denver, the owner of the Southwest Exchange Inc. acquired a number of small 1031 exchange companies, combined them together and then took $100 million of $150 million in funds to invest in some European breast implantation technology. 
• On the East Coast, the owner of another 1031 exchange company used the company as his private piggy bank, pulling another $100 million out of it for personal use.

Real estate investors looking to do a 1031 exchange should ask companies a few basic questions to help establish where their funds will be held and how safe they are.

1. Know WHO you are dealing with;

2.  Ask WHERE  the funds will be held and how they will be held;

3. Ask IF the 1031 exchange company has a fidelity bond, and if you can get a copy of it;

4. Ask IF the 1031 exchange company carries errors and omissions (E&O)Insurance on each exchange.

If you have 1031 exchange funds held with a company that doesn’t follow best security practices, the end result can be devastating.

You got it. The IRS is unforgiving on this issue. Why? Because you have the right to choose any 1031 exchange company you want. And you will still owe the taxes, even if you can’t buy a replacement property and you have lost your money.

How much could you owe? If you failed to complete the 1031 exchange for any reason, you’d owe capital gains tax on your profit, any state taxes that would have been due and the recapture on any depreciation you took.

In short, you could be completely wiped out, especially if you have been doing 1031 exchanges over and over again, deferring hundreds of thousands of dollars in profits.

Tags: 1031 Exchanges

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