What Happens When a 1031 Intermediary Goes Out of Business?

It becomes a HUGE mess. The IRS does NOT care because, once your time is up, you will either have to close or pay cap gains. From CoStar:

Another Blow to Faltering 1031 Real Estate Industry
At Least 450 Real Estate Deals Caught in Limbo Following LandAmerica 1031 Exchange Bankruptcy Filing
Already stung by cases alleging massive embezzlements and a string of failures of 1031 exchange accommodators, now comes another major blow to the business of tax-free real estate exchanges. LandAmerica 1031 Exchange Services Company Inc., one of the stalwarts of the business and one that many investors turned to for stability has run out of money, closed up shop and filed for bankruptcy court protection.

LandAmerica Financial Group Inc., Fortune magazine’s number one Most Admired Company in the mortgage services industry in 2007, shut down operations of its LandAmerica 1031 Exchange Services. In addition, the parent company is being forced to sell its primary title insurance subsidiaries: Commonwealth Land Title Insurance Co.; and Lawyers Title Insurance Corp.

The string of actions was touched off Friday Nov. 21 when Fidelity National Financial Inc., parent company of Chicago Title, cancelled a deal to buy LandAmerica Financial.

The following Monday, LandAmerica 1031 Exchange Services quit accepting new customers and terminated its operations.

That same day, the Nebraska Department of Insurance filed petitions for rehabilitation for Commonwealth and Lawyers Title under the Nebraska Insurance Code. That move likely would have meant turning over controlling of LandAmerica's title companies to Fidelity.

So two days later, LandAmerica Financial came to news terms on the sale of its title companies to Fidelity National, a deal that did not include LandAmerica 1031 Exchange Services. Thus the exchange accommodator and LandAmerica Financial the parent filed for bankruptcy to help facilitate the sale of the title businesses. The filing was made under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Eastern District of Virginia in Richmond, VA.

LandAmerica 1031 Exchange estimated that its assets and liabilities were between $100 million and $500 billion. LandAmerica Financial estimated both at more than $1 billion.

Separate from the title insurance drama, it appeared LandAmerica 1031 Exchange Services was experiencing problems of its own.

In a typical 1031 exchange, an exchanger sells its real estate investment and then has 45 days from the date of sale of the property to identify a like kind replacement property and it has 180 days from the date of the sale to close on the purchase of that replacement property without suffering any tax consequence.

The money from the sale of the first property is held in escrow by an exchange accommodator and released for the purchase of the replacement property. LandAmerica 1031 was one such firm.

While it held those funds, LandAmerica was investing a portion of them in auction rate securities -- in this case in investment grade securities rated A or stronger, including auction rate securities backed by federally guaranteed student loans.

Despite their investment grade ratings, LandAmerica 1031 got caught up in the troubles for such securities when the market for them froze earlier this year.

Its inability to sell or borrow against these securities precipitated its decision to terminate operations, the company said in a letter to customers.

"We understand that this situation is detrimental to you, and we can only assure you that we have taken every reasonable step possible to avoid the problem, including pursuing numerous liquidity options to no avail," LandAmerica's letter to customers said.

Customers are finding out just how detrimental it is after the filing of Chapter 11.

In a real estate alert to its clients, the law firm of DLA Piper in Atlanta, GA, wrote, "For taxpayers who have exchange funds at LandAmerica 1031 Exchange, the automatic stay imposed by the Bankruptcy Court in connection with the Chapter 11 filing will require Court approval of the release of any funds. Accordingly, it is highly unlikely that those funds will be immediately available, and they may not be available in time for the scheduled exchange closings, if any."

"In addition to negatively affecting the contractual obligations of those taxpayers to close on the purchase of identified replacement properties, the unavailability of exchange funds may disqualify the transaction from favorable Section 1031 tax treatment or have other adverse tax consequences," DLA Piper wrote.

According to bankruptcy filings made by LandAmerica 1031, there are approximately 450 taxpayers with pending exchange transactions.

There have been at least two lawsuits filed on behalf of such clients on an emergency basis seeking the release of those funds in time to complete pending transactions.

"I am deeply disappointed over the need to file for bankruptcy protection for the LandAmerica holding company and the 1031 company," said Theodore L. Chandler, Jr., chairman and CEO of LandAmerica Financial. "However, this sale of our principal domestic title operations to Fidelity National in this coordinated Chapter 11 filing and Nebraska rehabilitation action offers our stakeholders the best result available in this brutal real estate, credit and capital market environment."