Land Exchange’s Bankruptcy Sheds Light on Regulation Debate

By Beacon Staff

The bankruptcy of an Oregon-based real estate exchange firm with a Kalispell branch office has shed light on – and raised questions about – the industry.

“I was shocked to find they weren’t regulated,” said Richard DeJana, a Kalispell attorney. DeJana is representing an area resident who suffered six-figure losses when Summit 1031 Exchange, a firm specializing in tax-deferred land deals, collapsed last month after using customers’ money to fund its owners’ endeavors.

“Now, when he asks me if I think he’ll be able to get his money back, I honestly don’t know what to tell him,” DeJana said.

Summit 1031 Exchange closed its doors – including its Kalispell branch office – and filed for Chapter 11 bankruptcy in late December after announcing it has only about $13 million on hand of the $27 million it owes its clients. Rather than investing customers’ money in short-term, liquid securities, like most accommodators do, Summit’s principals had been putting millions of dollars into real estate deals, according to a posting on the company’s Web site.

The bankruptcy has left at least one local man out more than $1 million and may affect untold more here. Summit’s was one of a handful of similar scandals in the industry, and together they’re shedding new light on a business few people may know about and adding to a national push for more regulation.

Summit specialized in 1031 tax-deferred exchanges, a type of real estate investment named after a section of the IRS tax code. The exchanges allow investors to defer taxes on the sale of investment property so long as the proceeds from the deal are held by a third party, like Summit, and reinvested within 180 days in a similar property.

There are no federal regulations governing who can open a 1031 exchange company or what they must do to safeguard clients’ money. Most states, including Montana, do not regulate 1031 accommodators.

The exact number of qualified intermediaries is unknown: Under the law, a company can act as a 1031, but so can a friend. The trade organization Federation of Exchange Accommodators has more than 300 exchange firm members – eight of which are based in Montana.

After an exchange company in New York left more than 500 customers out $132 million in 2007, the Federation of Exchange Accommodators petitioned the Federal Trade Commission to apply registration and certification standards to the industry. The petition cited 23 cases involving $250 million losses.

Victims of abuse, including some here, have often voiced frustration with a system that required them to hand their money over to a third party but offers little protection against fraud.

But the Federal Trade Commission in August denied the request for more control.

“Frankly, they didn’t think it was enough of a problem in our industry that it merited their trying to step in and deal with it,” Hugh Pollard, president of the Philadelphia-based Federation of Exchange Accommodators, said. “Certainly, that’s good news, but it’s something we’d still support.”

The trade group is now trying to work through the IRS to get some standards and regulations implemented, Pollard said. Because of time and expense, another go at the FTC isn’t likely for a while, he added.

A handful of states, like Nevada, Idaho, California, Washington and Arizona, have implemented, or are considering, their own regulations – some of which are in response to abuses like Summit’s.

In October, California enacted minimum standards for 1031 facilitators. The new laws there prevent companies from combining clients’ money with operating accounts, or loaning funds to an affiliate. Facilitators there must also notify clients within 10 days if the company has been sold.

Prospective clients should ask 1031 exchange companies what kind of insurance they have, where their money will be invested and whether they will receive monthly statements, Pollard said. IRS employees said escrow and trust accounts are the safest way to park 1031 money, but those services require additional fees.

And while Pollard and the federation support more stringent guidelines, there’s little assurance that those would have helped Summit’s creditors, who are now beginning lengthy bankruptcy dealings and watching federal criminal investigators look into the company.

“People talk about regulation, too, but you look at this guy (Bernard) Madoff and he’s supposed to be regulated by the Securities and Exchange Commission – a lot more muscle and power than we’re talking,” Pollard said. “Just because it’s regulated doesn’t mean everything will be perfect.”