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September 12, 2013
Today the national legal counsel for one of the large 1031 companies took the flat position that her company will not cooperate in the rescue of any failing 1031 exchange.
The situation arose because an exchangor of theirs, whose exchange is about to fail, asked the company to assign the exchange agreement to S.Crow Collateral Corp., which could amend it to become an installment agreement so that the exchangor could retain tax deferral, but under Section 453 rather than Section 1031. The property which the exchangor identified was purchased by someone else, so, necessarily, the exchange will fail. The exchangor had already agreed to release the 1031 company from all liability or obligation because of the assignment.
It was quite an amazing conversation, and I think the world should know about it. I’ve reproduced the essence of it here.
1031 Attorney: It’s conventional wisdom that if we assigned the exchange agreement it would cause the exchange to fail.
S.Crow: As I believe you know, this particular exchange is going to fail anyway, so why would you refuse to agree to an assignment that at the very least could not make the situation worse?
1031 Attorney: Because the 1031 regulations don’t say we can assign, so we take the position that we can’t assign.
S.Crow: So, I take it that your position is that no active 1031 company can be sold or merged into another company, because the 1031 regulations don’t say that can be done, either.
1031 Attorney: I’ve participated in many merger and acquisition transactions involving 1031 companies, and typically the 1031 company which is bought by someone else continues in existence as an on-going entity.
S.Crow: But a 1031 company that is merged into the acquiring entity would cease to exist.
1031 Attorney: In a merger situation, the surviving company is deemed to stand in the shoes of the acquired 1031 company.
S.Crow: Well, similarly, under general contract law, when a contract is assigned the one to whom it is assigned is deemed to stand in the shoes of the one who assigned.
1031 Attorney: That’s true, but I attend many important meetings with the IRS about 1031 exchanges, and I believe that the IRS’ position is that the same company which begins a 1031 exchange must be the one that completes it.
S.Crow: Even though the regulations don’t say that?
1031 Attorney: Yes.
S.Crow: Even if that were correct, why would you be concerned about agreeing to an assignment of the exchange agreement, when you have a release signed by the exchangor?
1031 Attorney: If we were to do that even once the IRS might conclude that we are acting as the exchangor’s agent rather than as a qualified intermediary, and the IRS might determine that all of our exchanges must fail.
S.Crow: Even though the 1031 regulations don’t say that.
1031 Attorney: Yes. Besides, and don’t take offense at this, but if S.Crow Collateral Corp. were to fail to pay the exchangor the installment payments which you promise to make then the exchangor might sue us and claim that we should have known better than to assign to you.
S.Crow: Even though you have a signed release from the exchangor?
1031 Attorney: Yes.
S.Crow: There are multiple places in the 1031 regulations which say that if a 1031 accommodator pays the exchangor some or all of the proceeds from the relinquished property after the year of sale, then the exchange agreement is no longer an exchange under Section 1031 but is instead an installment sale under Section 453.
1031 Attorney: I am aware of those provisions, but our exchange agreement requires that we pay the proceeds of the relinquishment to the exchangor in a lump sum if the exchange fails.
S.Crow: I realize that, but, even without assigning the exchange agreement to S.Crow Collateral Corp., would you permit your company to agree with the exchangor to amend the exchange agreement to provide for installment payments to the exchangor by your company, instead of paying in a lump sum?
1031 Attorney: No, we’re not set up for that operationally, to make installment payments.
S.Crow: All right, so why not amend the exchange agreement to provide for installment payments, thereby taking the agreement out from under the 1031 regulations you’re worried about, and turning the deal into an installment sale? Then you could assign the amended agreement, which would then be an installment contract rather than an exchange, to S.Crow Collateral Corp., which would take over the payment obligation from you.
1031 Attorney: That’s not the business we’re in. We’ve had a nice conversation today. (End of conversation)
The 1031 attorney’s disdain for her company’s exchangors is a scandal. I believe she fears that her company would lose business if exchangors were to find out that failing exchanges can be rescued (who wants to offer a product and admit that it might fail?) or that exchanges are generally unnecessary in the first place. Her company doesn’t have to lose out; it could thrive by offering a better product.—Stan Crow
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The Latest Installment addresses situations, questions and issues which are brought to us in the course of the consideration, negotiation or execution of transactions. We don't use the real names of parties to transactions, and we may edit the statement of the question to try to tell the story better. Please feel free to comment, or to take issue, or to raise your own question or situation. If you do the latter, please do not relate any confidential information.
The Latest Installment blog is edited by Stanley D. Crow, who is president of S.Crow Collateral Corp.