Tag Archives: capital gains

Wachovia Sued for Millions in 1031 Exchange Fraud

Wachovia Corp., the troubled banking and financial services company that was the subject of a bidding war between Citigroup Inc. and Wells Fargo & Co., the target of a $60 billion lawsuit from Citigroup, and that has also been linked to money laundering by Mexican and Columbian drug cartels, has now been sued by the victims of  a fraudulent scheme to steal millions of dollars in client funds held by The 1031 Tax Group LLP (1031TG), a 1031 exchange qualified intermediary scam operated by Ed Okun.

Okun was indicted, along with Lara Coleman, on July 10, 2008, by a federal grand jury in Richmond, Va., and charged with conspiracy to commit mail and wire fraud, conspiracy to commit money laundering, wire fraud, mail fraud, money laundering, bulk cash smuggling and forfeiture. Okun is also charged with one count of making false statements.

The new lawsuit by the 1031TG Trustee alleges that Wachovia aided and abetted breaches of fiduciary duty by Edward Okun and Lara Coleman against the 1031 Tax Group Debtors, and seeks to recover more than $140 million of damages arising from such actions.

According to a lawsuit filed in the Southern District of New York on October 2, 2008, by the Trustee for the bankrupt tax-deferral company, “Wachovia was entwined in all aspects of the 1031 debtors’ operations, Okun’s personal finances and Okun’s other businesses” and assisted in the fraud by transferring $240 million to “inappropriate” accounts before the tax firm collapsed and Okun was arrested.

The lawsuit seeks recovery of more than $43 million of conveyances allegedly made to Wachovia in the form of cash and mortgage liens, and the imposition of equitable liens and constructive trusts on several properties in which Wachovia continues to hold liens.

The complaint also asserts that Wachovia housed more than 250 bank accounts for the 1031 Tax Group Debtors as well as other Okun Entities; provided several personal loans to Okun; and made commercial loans to Okun-related entities, such as IPofA affiliates. 

The lawsuit further alleges that during the course of this relationship, Wachovia learned that Okun and others were misappropriating funds of the 1031 Tax Group Debtors, but did nothing to stop the misappropriations, and in fact took steps that furthered the misconduct.

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What Property Qualifies for a 1031 Exchange? (Part Three)

This is Part Three of our series on what property qualifies for a 1031 exchange.  You can also see Part One and Part Two.

In deciding whether a particular property has been held for productive use in a trade or business or for investment, the IRS looks at how you have characterized that property on your tax returns. If you have historically taken depreciation on or reported rental income on a property, there should not be any problem with that property qualifying for a Section 1031 exchange.

In addition, it is important to note that the IRS has ruled that the Section 1031 requirement that property be “held for productive use in a trade or business or for investment” excludes primary residences, vacation homes (when they are not held for investment), and second homes. When a personal residence is exchanged for other property, the Section 121 exclusion rule applies (providing that up to $250,000 of capital gain, or up to $500,000 for a married couple, is not taxable), not Section 1031.

The burden of establishing that a property is held for productive use in a trade or business or for investment (and not for a non-qualifying use such as inventory for resale) is on the exchanger, not the government.

The “for investment” requirement is somewhat trickier than the requirement that the property be “held for productive use in a trade or business,” since all property could conceivably be considered an investment.

Each property must be evaluated on a case-by-case basis. What the IRS looks at is the intent of the property owner and whether, on balance, the property is held for investment purposes or personal enjoyment.

If you want to do a Section 1031 exchange of property that you now use as your primary residence or as a second or vacation home, you must first turn it into qualifying property that is productively used in a trade or business or for investment. In other words, even property you have used as a primary residence, a second home, or primarily for personal enjoyment as a vacation home, may still qualify for an exchange under Section 1031 – if you re-characterize that property by using it for business purposes for a sufficient period of time.

The date the IRS uses to determine whether property has been held for a qualifying business use is the date of the transaction; any previous use is theoretically irrelevant. There is also no clear rule regarding how long a “holding period” is required in order to re characterize property and qualify for a Section 1031 exchange. Tax advisors recommend a period of one to two years (opinion is split on which time period is sufficient, but in no case less than 12 months) in the new use, and that you are able to report rental income and deduct depreciation and other business expenses regarding the property on your tax returns for that period of time.

It should also be noted that one can also exchange many types of non-real estate property that is held for investment or used in a business. For example, an airline can sell its airplanes as part of a like-kind exchange and avoid recapture of depreciation.

But the “like-kind” requirement is interpreted much more narrowly by the IRS for non-real property than for real property. While any real property held for trade or business use or for investment and located in the United States can be exchanged for any other real property held for trade or business use or for investment use and located in the United States, non-real estate properties exchanged under Section 1031 must be essentially the same type of asset.

Airplanes can be exchanged for airplanes, trucks for trucks, pizza ovens for pizza ovens, oil digging equipment for oil digging equipment; but airplanes cannot be exchanged for trucks, and oil digging equipment cannot be exchanged for pizza ovens. In addition, franchise rights and certain types of licenses can also be exchanged under Section 1031.

The replacement property, like the relinquished property, must meet certain requirements to be eligible for a Section 1031 exchange.

First, the replacement property, like the relinquished property, must be property, not securities or services, and it must be intended for “productive use in a trade or business or for investment.” 

Section 1031 applies only to “the exchange of property…for property.” For this reason, you cannot exchange property for securities or services. As with the relinquished property, this is a matter of the how the exchanger intends to use the property. The use of either property by the other party in the exchange is irrelevant.

Second, the replacement property must be of a “like-kind” to the relinquished property. What does “like-kind” property mean? In a typically obtuse ruling, the IRS has stated that:

“As used in IRC 1031(a), the words like-kind has reference to the nature or character of the property and not to its grade or quality. One kind or class of property may not, under that section, be exchanged for property of a different kind or class. The fact that any real estate involved is improved or unimproved is not material, for that fact relates only to the grade or quality of the property and not to its kind or class. Unproductive real estate held by one other than a dealer for future use or future realization of the increment in value is held for investment and not primarily for sale.”

Got it? Okay, now let’s unpack the “like-kind” requirement in language that makes sense.

As used in Section 1031, “like-kind” property does not mean property that is exactly alike – or even alike at all in any normal sense. Instead, the IRS interprets the “like-kind” requirement very broadly – so broadly that if two or more properties are located in the United States and are held for productive use in a trade or business or for investment, they are considered “like-kind” property under Section 1031.

In other words, all real property located in the United States is considered “like-kind” to all other real property located in the United States.

Conversely, foreign property such as property located in Canada or Mexico) or in overseas U.S. possessions, such as Guam or Puerto Rico, is not considered “like-kind” to any property located in the United States.

But urban real estate in Los Angeles can be exchanged for a ranch in Utah, a ranch in Utah can be exchanged for a factory in Delaware, a factory in Delaware can be exchanged for a gas station in Las Vegas, and a gas station in Las Vegas can be exchanged for a conservation easement in Seattle. The quality or type of the real property does not matter so long as each real property is located in the United States. Under Section 1031, an apartment building in Chicago can be exchanged for an office building in Los Angeles, an office building in New York can be exchanged for a car wash in Nashville, a car wash in Seattle can be exchanged for a tenancy-in-common ownership in a resort in San Diego, and a tenancy-in-common ownership in a mall in Arizona can be exchanged fortimberland in Oregon, a farm in Wisconsin, a factory in Pennsylvania, or a gas station in Louisiana.

The fact that one property is improved and the other property is unimproved, or that one property is in a run-down part of a city while the other property is located in an upscale neighborhood is irrelevant.  Moreover, even partially completed property can, if properly identified, qualify as “like-kind” property with completed property. The “like-kind” requirement refers to the nature or character of property, not to its grade or quality. As long as a property is located in the United States and is “held for productive use in a trade or business or for investment,” it is “like-kind” to every other property located in the United States that is “held for productive use in a trade or business or for investment.”

See also “What Property Qualifies for a 1031 Exchange?” Part One and Part Two.

To contact Melissa J. Fox for 1031 exchange or other real estate or legal services, send an email to strategicfox@gmail.com

Windfall for Lender – Or Will Natural Gas Discovery Benefit Victims of Ed Okun’s 1031 Tax Group Scam?

There’s a new ripple in the story of indicted 1031 exchange scammer Edward Okun, the 1031 Tax Group, and their victims.

Cordell Funding is a Miami-based hard money mortgage lender. Last fall, Cordell Funding sued Okun to recover $17 million it had loaned to Okun before his fraud-riddled real estate empire collapsed into bankruptcy actions and criminal indictments.

Cordell Funding initially sued Okun in a New York state court, but a federal judge transferred the suit to the U.S. Bankruptcy Court in Manhattan, where Gerard McHale, the court-appointed Chapter 11 trustee of Okun’s 1031 Tax Group, was selling off Okun’s assets.

As part of that bankruptcy case, McHale turned over the rights to several Okun properties to Cordell. One of the properties that McHale turned over to Cordell was the Shreveport Industrial Park, a nearly empty 42-year-old, 956,735-square-foot Class C industrial distribution building at 9595 Mansfield Road in Shreveport, Louisiana.

It wasn’t worth much — certainly not the $17 million that Cordell said it was owed by Okun.

Then natural gas was discovered in the area. 

In fact, it was discovered that under the Shreveport Industrial Park is the largest onshore natural gas field in North America.   It could hold as much as 20 trillion cubic-feet equivalent of natural gas reserves.

The mineral rights lease for the Sheveport Industrial Park is now valued at somewhere between $30 and $60 million.

And property values for the area have soared.

It looks like Cordell Funding got a windfall from the bankruptcy court. 

But when the natural gas field was discovered, bankruptcy trustee McHale went back to court to have the bankruptcy judge of the 1031 Tax Group vacate the order giving Cordell Funding rights to the Shreveport property. At the same time, McHale has asked the bankruptcy judge to approve a mineral rights lease with PetroHawk Energy for the benefit of the 1031 Tax Group victims.

Now whether Cordell Funding or the hundreds of creditors of the 1031 Tax Group gets the millions of dollars from the Shreveport natural gas discovery will be determined by the bankruptcy court.

UPDATE:

For the latest on Ed Okun (new federal indictments, plus the indictments of Laura Coleman and Richard B. Simring), click here.

1031 Exchanges Between Related Parties — and Other 1031 Exchange Issues

Special rules govern 1031 exchanges between related parties, and running afoul of them can turn your tax-free exchange into a taxable sale. 

Here is an example:

Brad and Ellis are brothers. Brad lives in Dallas, Texas, where they grew up, and Ellis lives in a suburb of Boston, where he settled after law school. As a result of an inheritance from their grandparents, Brad and Ellis own several houses in Dallas as joint tenants.

They have rented these houses to tenants and divided the expenses and the profits equally between themselves. The largest of these houses is a five bedroom ranch style home sitting on 3.5 acres.

Brad now wants to move into this house, and wants Ellis to sell him his one-half ownership so that Brad can own the house on his own. The house’s fair market value at the time of their inheritance was $600,000. Its current fair market value is $950,000.

Ellis points out to his brother that if he sells his share of the house to Brad, he will be required to pay capital gains taxes of approximately $45,000. Instead, Ellis proposes that they do a Section 1031 exchange, in which he and Brad would swap their portions of ownership of several of the properties that they own together.

Specifically, Ellis proposes that Brad exchange his joint ownership portion of two of their smaller properties with a combined current fair market value of $890,000 for the ranch house property worth $950,000 that Brad wants. Once Ellis has sole ownership of these properties, Ellis plans to remodel and sell them within the next two years.

Does Ellis’ proposal make sense?

What about the $60,000 difference in value between the property that Ellis wants to exchange in return for the ranch house?

Are there any special problems for the brothers to consider, and is there anything that they could do to avoid these problems?

The first point to recall here is that special rules apply to Section 1031 exchanges with anyone who is a “related party” to the taxpayer.

Related parties include family members, such as spouses and lineal descendants (parents and children, brothers, sisters, grandparents and grandchildren), as well as corporations, partnerships, trusts, and estates in which a related person owns more than 50 percent either directly or indirectly.

You can engage in a Section 1031 exchange with these related parties, but only if neither the relinquished property nor the replacement property is sold or otherwise disposed of within two years of the transfer.

The IRS monitors exchanges between related parties by requiring that both parties file a special tax form, Exchange Form 8824, in the year of the exchange and for the next two years.

In this example, Brad and Ellis can exchange properties, but the exchange will be treated as a taxable sale if either the relinquished property or the replacement property is sold or otherwise disposed of within two years of the transfer.

Thus, if either Brad or Ellis sells or otherwise disposes of the property involved in the exchange within two years of the transfer, the IRS will retroactively disqualify the original transaction as a Section 1031 exchange and order that capital gains taxes be paid.

Moreover, if either brother sells or disposes of the property before the two year holding period is over, the other brother will be required to pay capital gains taxes on the transaction even though he was not the party who sold or disposed of the exchanged property.

Here, if Ellis carries out his plans to remodel and sell the property he receives in the exchange within the next two years, the IRS will retroactively declare the exchange to be a taxable sale and both Ellis and Brad will be required to pay capital gains taxes.

Accordingly, Brad should consider doing the exchange only if Ellis agrees, in the written documents controlling the exchange, to a provision specifying that if either party triggers the taxation of gain within the two year holding period, the innocent party will be reimbursed for the adverse tax consequences.

In addition, a transaction to qualify as a Section 1031 exchange, both the relinquished and the replacement properties must be held for use in a trade or business, or for investment. In this example, Brad wants to move into one of the exchanged properties and use it as a personal residence.

If he does so, the property is not held for use in a trade or business, or for investment, and the transaction will not qualify as a Section 1031 exchange. Brad can move into the five bedroom ranch style home only after a prudent holding period of at least two years, during which he uses the property in a trade or business or for investment.

Brad should also be concerned about the $60,000 difference in fair market value between the property he will be giving up and the property he will receive in the exchange.

In order to use Section 1031 to avoid paying any capital gains taxes, the basic rule is to exchange up, never down.

Here, if the exchange were to go forward as Ellis proposes (that is, Brad would receive property with a fair market value of $890,000 in exchange for property with a fair market value of $950,000), then Brad will have a capital gain of $60,000 on which he will required to pay capital gains taxes.

To contact Melissa J. Fox about serving as a qualified intermediary, attorney, or broker, or for other 1031 exchange, legal, or real estate services , send an email to strategicfox@gmail.com

 

When Can — or Should — You Revoke an Identification in a 1031 Exchange?

Sometimes it is necessary to revoke an identification in a 1031 exchange.

For example, Dwight is doing a Section 1031 exchange involving a 300 unit apartment complex he owns in San Antonio, Texas, and has identified three replacement properties under the Three Property Rule. He then learns that one of the properties he has identified is no longer available.

What should he do?

Dwight should revoke his identification of the unavailable property and identify a new replacement property in its place.

An identification of replacement property can be revoked at any time before the end of the identification period

If Dwight did nothing, he would be left with only two replacement properties, and if those properties did not close he would be unable to complete a Section 1031 exchange.

If, however, Dwight timely revokes the identification of the property that is no longer available — or appropriate — for whatever reason — then he can add a new property to his identification list.

For maximum security when using the Three Property rule, the goal is to end the identification period having named three qualified and suitable replacement properties, any of which can be used as a replacement property in the exchange.

This strategy also applies to other 1031 exchange identification rules (the 200 Percent Rule and the 95 Percent Rule).

Remember, too, that the revocation of identification must, like the earlier initial identification, be made in a written document signed by you that unambiguously describes the property whose identification you have chosen to revoke.

And as with the earlier identification, a revocation of identification must be hand delivered, mailed, telecopied, or otherwise sent to either the person obligated to transfer the replacement property to the exchanger, or any other person involved in the exchange other than the taxpayer or a disqualified person.

To contact Melissa J. Fox about serving as a qualified intermediary or for other 1031 exchange services, send an email to strategicfox@gmail.com

Can You Use a 1031 Exchange for Non-Real Estate Assets?

Section 1031 exchanges are not limited to real estate.

To qualify for the tax benefits of an exchange under Section 1031, the property you want to exchange (or relinquish) needs to be “held for productive use in a trade or business or for investment.”

The property does not have to be real estate.

But when you’re exchanging non-real estate assets, the requirement that the relinquished property and the replacement property be “like kind” is much more narrowly construed.

Here is an example:

Stan is an avid collector of boxing memorabilia. His collection includes posters for the famous fight between Joe Lewis and Max Schmeling, several pairs of boxing gloves used in the ring by Mohammed Ali, a gold platted championship belt once owned by Jake LaMotta, a mouth piece that belonged to Sugar Ray Robinson, a pair of Archie Moore’s boxing trunks, and a wedding ring worn by Gentleman Jim Corbett, among other treasures.

He is thinking about selling his collection to buy a tenancy-in-common interest in a new hotel that his friend Barbara is opening in Las Vegas, Nevada. 

Stan has heard about the tax benefits of using Section 1031. Can he use Section 1031 to exchange his collection of boxing memorabilia for an ownership interest in Barbara’s Las Vegas hotel.

1031 exchanges are not limited to real estate. One can also exchange other types of tangible non-real estate property held for investment or used in a business. But the “like-kind” requirement is interpreted much more narrowly by the IRS for non-real property than for real property.

While any real property held for trade or business use or for investment and located in the United States can be exchanged for any other real property held for trade or business use or for investment use and located in the United States, non-real estate property exchanged under Section 1031 must be essentially the same type of asset.

Airplanes can be exchanged for airplanes,trucks for trucks, pizza ovens for pizza ovens, oil digging equipment for oil digging equipment, but airplanes cannot be exchanged for trucks and oil digging equipment cannot be exchanged for pizza ovens.

Because Stan wants to exchange his boxing memorabilia for a tenancy-in-common interest in a hotel – an asset of a very different kind – the exchange would not be allowed under Section 1031.

If Stan wants to exchange his boxing memorabilia under Section 1031, he should consult his tax advisor to determine what kind of assets would be considered “like-kind” to his collection.

To contact Melissa J. Fox about serving as a qualified intermediary or for other 1031 exchange services, send an email to strategicfox@gmail.com

The Role of a Qualified Intermediary (QI) in a 1031 Exchange

Because you are absolutely not allowed to receive (or directly control) any of the proceeds from the transfer of your relinquished property in a 1031 exchange — if you do, you will instantly turn your tax-free Section 1031 exchange into a taxable sale — it is necessary to employ the services of a Qualified Intermediary (also sometimes called a QI or an exchange accomodator) in the 1031 exchange process.

A Qualified Intermediary is the person or business entity that holds the exchange proceeds and acts as a “safe harbor” or barrier between the taxpayer and the proceeds from the transfer of the exchange property, so that these proceeds never come into your actual or constructive possession, but at the same time can be used to obtain new property for you.

The sale proceeds go directly to the Qualified Intermediary, who holds them until they are needed to acquire the replacement property. The Qualified Intermediary then delivers the funds directly to the closing agent.

If the taxpayer meets the requirements of this safe harbor, the IRS will not consider the taxpayer to be in receipt of the funds.

The IRS originally refused to allow deferred exchanges under Section 1031 because the taxpayer received the proceeds from the transfer of the relinquished property before using these proceeds to obtain replacement property.  To the IRS, this receipt of funds in the period between the completion of the exchange made the transactions into a series of sales and purchases rather than a true exchange.

The current law allows the taxpayer a limited period of time after the transfer of relinquished property to identify and obtain title on replacement property, but also reflects the IRS’s concern over the taxpayer’s receipt of the proceeds in the interim by requiring that there be no receipt of cash or other non-qualified property by the taxpayer before both ends of the exchange have been completed.

As a result of this rule, a new professional came into being: the Qualified Intermediary.

Since the taxpayer can not receive the proceeds from the relinquished property until title to the replacement property is obtained, and these same proceeds are used to acquire that replacement property, someone needs to hold on to the funds, acquire the relinquished property from the taxpayer; transfer the relinquished property to another party, acquire the replacement property from another party, and then finally transfer the replacement property to the taxpayer. This is the job of the Qualified Intermediary.

Specifically, the Qualified Intermediary:

  • Enters into a written agreement (called an exchange agreement) that documents all important aspects of the exchange.
  • Acquires the relinquished property from the taxpayer.
  • Transfers the relinquished property to another party.
  • Acquires the replacement property from another party.
  • Transfers the replacement property to the taxpayer.

The properties are usually deeded directly between the parties, just as in a normal sale transaction. However, in a Section 1031 exchange, unlike an ordinary sale, the taxpayer’s interests in the property purchase and sale contracts are first assigned to the Qualified Intermediary. The Qualified Intermediary then instructs the property owner to deed the property directly to the appropriate party (for the relinquished property, its buyer; for the replacement property, the taxpayer).

Because the proceeds can never come into your actual or constructive possession before the completion of the exchange, there are limitations on who can serve as a Qualified Intermediary in a Section 1031 exchange.

Anyone who is an agent of the taxpayer at the time of the transaction, or has been an agent of the taxpayer within the past two years, is disqualified from being a Qualified Intermediary of the taxpayer.

This prohibition includes anyone who has been the taxpayer’s employee, attorney, accountant, investment banker or broker, real estate broker or agent within the past two years from the date of the transfer of the first of the relinquished properties.

In practical terms, this prohibition eliminates your present lawyer or accountant from serving as your Qualified Intermediary.

However, assuming there are no other disqualifying activities or relationships, you may use a real estate agent who has previously helped to put together a Section 1031 exchange for you, as well as a business entity or person who has performed routine financial, title insurance, escrow, or trust services for you.

Despite the importance of using a Qualified Intermediary in the Section 1031 exchange process, qualified intermediaries are generally not regulated (the single exception is in Nevada).

Remember that the Qualified Intermediary is an actual principal in the exchange transaction. You must assign to the Qualified Intermediary your interest as seller of the relinquished property and your interest as buyer of the replacement property. The Qualified Intermediary will be responsible for holding the proceeds of the transaction in a separate exchange account until the funds are used to obtain the replacement property.

For these reasons, your Qualified Intermediary must be someone you trust to hold your money or land and who has plenty of fidelity bond insurance in place.

You should also take special note of the Qualified Intermediary’s fund management program, asking in whose name the funds are held and where, and what the requirements are for deposits and withdrawals.

In addition, you should also make sure that your Qualified Intermediary is experienced in the Section 1031 exchange process.

Remember that the rules governing the use of the proceeds of the various transactions in Section 1031 exchanges can be complicated, and that a mistake by your Qualified Intermediary can result in you paying thousands of dollars in taxes that could, and should, be avoided.

Remember, too, that it is not the job of the Qualified Intermediary to provide legal or specific tax advice to the exchanger. On these critical matters, you must have expert and trustworthy advice from other professionals.

To contact Melissa J. Fox about serving as a qualified intermediary or for other 1031 exchange services, send an email to strategicfox@gmail.com