1031 exchange update: Connecticut passes regulation of QIs

Over the past few years Legal 1031 Exchange Services, Inc. has actively sought to have legislation enacted in Connecticut pertaining to the regulation of qualified intermediaries (QIs). The role of the QI, as defined in Section 1031(k)-1g(4), is to prepare 1031 exchange documentation in accordance with section 1031 and to hold the exchange funds during the exchange transaction so that the taxpayer is not deemed to receive constructive receipt of the proceeds from the sale of the relinquished property. Although there is no federal regulations, some states have enacted legislation to protect taxpayers performing a 1031 tax-deferred exchange. Legal 1031 Exchange Services worked with the Federation of Exchange Accommodators to put forth proposed legislation to the Connecticut Banking Committee and twice provided testimony before the committee in favor of the proposed bill. On June 18­th Connecticut governor Malloy signed House Bill No. 6339 which sets forth guidelines and requirements pertaining to minimum fidelity bond and errors and omissions insurance coverage, as well as inclusion of a prudent investor standard requiring the exchange funds to be deposited in a manner that provides liquidity and preserves principal. The new legislation will be effective October 1st. The Resurrection of Reverse 1031 Exchanges Reverse exchanges appear to be gaining traction in the current real estate market after numerous years of dormancy. The reverse exchange differs from a typical "forward moving" delayed exchange in that the exchanger takes title to their replacement property first, and thereafter sells their relinquished property. In order to properly structure a reverse exchange, the qualified intermediary forms an entity known as an Exchange Accommodation Titleholder (EAT), which is a limited liability company (LLC), to take title to the replacement property. The EAT acts as a "straw man" to hold title until the exchanger sells its relinquished property. When the seller transfers the replacement property to the EAT's LLC a transfer tax is due and payable. Once the exchanger sells its relinquished property, the EAT transfers the membership interest in the LLC, which owns the replacement property, to the exchanger. The transfer of this membership interest does not involve a change in beneficial ownership since the EAT was merely acting as a "straw man" to structure the reverse 1031 exchange, and does not generally involve the payment of a second transfer tax. However, the taxpayer does need to be cognizant of potential costs for duplicate transfer taxes in certain jurisdictions. In a recent transaction, Legal 1031 sought guidance from the New Hampshire Department of Revenue Administration (the NH DRA) to confirm that the state would not levy a second transfer tax upon the transfer of the property from the EAT to the taxpayer. Legal 1031 put forth the position on behalf of our client that such transaction should not be subject to an additional tax levy, and ultimately the NH DRA concurred with our position. The NH DRA previously charged a duplicate transfer tax in all reverse exchanges until Legal 1031 vigorously advocated its client's position that no duplicate transfer tax should be due. About Legal 1031 Exchange Services, Inc. Whether seeking to redeploy assets, diversify or consolidate one's holdings, or even simply reduce management responsibilities, prudent investors will seek to change up their investments in a tax efficient manner. A 1031 exchange continues to be one of the best tools to accomplish such goals. Legal 1031 Exchange Services, a QI with offices in Conn., N.Y., Mass. and Fla., will prepare the paperwork necessary to structure the transaction as an exchange and also act as the independent third party to hold the exchange proceeds. Call us at (877) 628-1031 to discuss how we can help you and your clients. Matthew Scheriff, CPA, CES, is executive vice president at Legal 1031 Exchange Services, Inc., New York, N.Y.