Tax-deferred real estate exchange investors who've been victims of bankruptcy filings by intermediary companies in recent months could be in for some relief from the IRS.

In a letter to Senator Chris Dodd of Connecticut, chairman of the Senate Banking Committee, the IRS said it is aware of the financial pain, and potentially severe tax liabilities, faced by Section 1031 exchange investors around the country.

Among the most prominent recent bankruptcy filings that have interfered with thousands of exchanges: Land America 1031 Exchange Services, Inc., a subsidiary of title insurance giant Land America; and Summit Accommodators.

In both cases, the intermediary firms were holding millions of dollars of exchange participants' money, which were then frozen by the bankruptcy filings.

So-called "qualified intermediaries," or "QIs", play a pivotal role in tax-deferred exchanges. They hold the proceeds of investors' transactions in escrow while the investors are locating replacement properties to qualify for federal tax deferral.

During that interim period, the investors have no access to the escrowed funds. Though many QIs deposit escrowed funds into FDIC-insured bank accounts, some exchange agreements do not require that.

In the case of Summit, for instance, the company reportedly had lent millions of dollars of investors' escrow money to an affiliate , which in turn invested it into real estate ventures.

At the time of the bankruptcy filing, roughly $14.2 million in investors' money reportedly was missing -- making it impossible for them to acquire replacement properties to complete their tax-free exchanges.

More than $419 million in investors' escrowed money was tied up in the LandAmerica filing, exposing hundreds of investors to potential capital gains taxes because their exchanges could not be completed.

In its letter to Dodd, the IRS said it has no statutory authority to extend Section 1031 deadlines to accommodate investors harmed by QI bankruptcies. But it indicated that it is "considering some type of relief for taxpayers in this situation." The letter did not say what types of relief might be in the cards. "Investors are really in a tough spot," said Mary Foster, a past president of the Federation of Exchange Accommodators, a 1031 industry group.

Bill Horan of Realty Exchange Corp.in Gainesville, Virginia, told Realty Times there's a second category of investors who need help: victims of outright fraud, where QIs "took the (escrowed) money for themselves."

Ed Okun of Miami, who ran multiple QI firms, was convicted in March of defrauding hundreds of exchange investors of $126 million in a Ponzi scheme where funds allegedly were used for Okun's personal activities - including a divorce settlement and purchase of a 131-foot megayacht.

Published: July 24, 2009

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consmer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.