Bend, Oregon-based Summit 1031 Exchange filed for Chapter 11 bankruptcy protection late last year after it conceded it had only about $13 million of the $27 million is cash it owed to its clients, who lived in eight different states. Summit is one of several high-profile collapses of 1031 exchanges in the past year. As was the case in other prominent 1031 exchanges, clients reportedly believed that their funds were deposited in secured accounts and thus were not at risk of being lost.
The losses reportedly stem from loans made by Summit to Inland Capital, which is owned by Summit. Summit acknowledge these loans in an online statement. Inland in turned loaned the money to various others in the real estate market. When those loans went sour in the wake of a real estate collapse, Inland, and thus Summit, were left holding the bag.
To add insult to injury, clients of Summit who lost money in its collapse must now pay taxes on those funds.
As a general rule, funds entrusted with a QI are not thought of as suitable for investment, and certainly not potentially high-risk real estate investment. The funds are proceeds from or for the property exchanges managed by the QIs.
The story of Summit and others like it highlight the need for careful evaluation of QIs prior to signing on with them. QIs hold funds, sometimes substantial funds, on behalf of their clients. It is up to the client to be satisfied as to the amount of risk being taken with those funds by the QI. The most low-risk option is to have the funds sequestered and put into an insured account. While clients might assume this is what’s happening, it is not always the case. Asking the QI for statements to this affect will provide some safety in this regards.
What is a 1031 Exchange?
The IRS many years ago wrote into code the opportunity for property owners to defer the taxes on capital gains for the sale of real estate by creating the 1031 exchange. In order to qualify for the tax benefit, property owners must work through a QI. Funds from the proceeds of sales of property are sent to the QI and then used to purchase replacement properties.
There are other rules to these tax codes, including the fact that properties involved in the exchanges must be “like-kind,” meaning, they must be the same type of property. How like-kind is specifically define varies depending on whether the property is owned by an individual or a business, but in general the definition is a little more liberal for business owners.
There are tight timelines associated with a 1031 exchange. In order to qualify for the tax benefit, replacement properties must be identified within 45 days of the sale of the original property, and the purchase must be complete within 180 days.
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