A $150 billion industry used by investors to defer taxes on the sale of investment property is unregulated. Efforts to change that on a federal level have gone unheeded.
The trade organization Federation of Exchange Accommodators petitioned the Federal Trade Commission in August 2007 to come up with registration and certification standards for the industry after a company in New York left more than 577 customers out of $132 million they had invested.
The petition cited 23 cases involving $250 million losses.
But the Federal Trade Commission in August denied the request for more oversight.
"The FTC said there was not enough fraud, and it did not warrant oversight," said Mary B. Foster, past president of the federation and owner of a 1031 company in Washington state. "It needs to be kind of rampant fraud for them to do the oversight of the industry."
The ruling came three months before LandAmerica 1031 Exchange Services Inc. declared bankruptcy, leaving 450 customers with more than $330 million in investments tied up.
Now, that bankruptcy is shedding new light on an industry few people may know about.
The exchange company industry dates to the 1920s and an Internal Revenue Service code, 1031. The code allows people to defer taxes on the sale of investment property so long as the proceeds from the deal are held by a third party and reinvested within 180 days in a similar property.
The exact number of qualified intermediaries is unknown, but the federation has 310 exchange firm members.
A company can act as a 1031, but so can a friend, said Bradley T. Borden, a Washburn University School of Law professor, and author of "Tax-Free Swaps."
The IRS said escrow and trust accounts are the safest way to park 1031 money. But that requires additional fees, Borden said.
A handful of states have rules regulating exchange firms. Virginia is not among them. Officials with the State Corporation Commission, the attorney general's office and the Department of Taxation said legislation is not in the works.
Spurred on by the failure of a 1031, Nevada now requires exchange accounts to be kept separate and placed in an FDIC or other insured account. "The legislature felt that it needed to be more tightly regulated," said Steven Kondrup, deputy commissioner for Nevada's Financial Institutions Division.
In Idaho, exchange funds must go into escrow accounts. Colorado, Arizona and Washington are creating regulations.
Contact Emily C. Dooley at (804) 649-6016 or edooley@timesdispatch.com.
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