LandAmerica Exchange Services (LES) company announced on November 28, 2008 that it is ceasing operations and will no longer be taking new clients. In a letter to customers, LES explained that it is closing its doors after suffering investment losses in now illiquid auction rate securities. Given these losses, the company was no longer able to borrow, and was forced to close its operations.
“LES has long invested 1031 deposits only in Investment Grade Securities Rated A or stronger, including auction rate securities backed by federally guaranteed student loans. Our goal for the exchange funds has been to maintain the full liquidity necessary to meet customer withdrawal demands. The auction rate securities in our exchange funds, which were sold to us by certain financial institutions, were highly liquid for many years. As has been widely publicized, the auction rate securities market froze earlier this year, and that extenuating circumstance prevents us from liquidating the auction rate securities held in the exchange funds,” said a letter from the company, dated from November 2008.
Lawsuit filed against LES
Investors in January joined in a $330 million class action lawsuit against LES, and accused the company of fraud. Investors, which reportedly numbered about 450, had about $400 million on deposit. Roughly 50 of those customers did not have their funds in that account, and their ability to recoup their deposits might be better.
Those deposits were typically assumed to be safe and of a short-term nature. As a Qualified Intermediary, LES held the funds from property sales so that the sellers could take advantage of the tax benefits offered through the 1031 exchange. Those funds would have been used to purchase “like-kind” replacement properties for the sellers, which would make the exchange qualify under the IRS code.
LES customers were both individuals and companies. “We understand that this situation is detrimental to you, and we can only assure you that we have taken every reasonable step possible to avoid the problem, including pursuing numerous liquidity options to no avail,” the letter continued.
In May 2009 a bankruptcy court judge ruled that the funds that remain in the account belong to the bankruptcy estate and not to the depositors, further angering for LES customers. LandAmerica had been in the 1031 exchange services business since 1990.
Common business transaction; uncommon outcome
LES’ 1031 business is common. The IRS has provisions that allow people who sell one property and then exchange it with a “like-kind” property to deferred taxes on the gains from the sales. These codes have been in effect since the 1920s and gained popularity after changes in the code that occurred in the early 1990s. These exchanges are used for a variety of reasons, beyond the tax benefit. They can also help reduce the expense of transactions that allow property owners to exchange a number of small properties for large ones, or to buy new property with more favorable tenant profiles.
The ultimate fate of the deposits of LandAmerica Services 1031 exchange services customers will reportedly be tied up in the courts for many months to come.
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