LandAmerica screws 1031 exchangors!

"LandAmerica Financial has sent a notice to its 1031 exchange customers this morning informing them that it was terminating these operations. The problem, it said, was that a portion of the 1031 funds are invested in illiquid auction rate securities that it cannot access. “Our inability to sell or borrow against these securities have precipitated our decision to terminate operations,” according to the letter."

Click here for full article

This is huge news and will impact the investment real estate community significantly! Too bad Bounty can't clean up this mess...

What is a 1031 exchange?

A 1031 exchange is a simple strategy and method for selling one property, that's qualified, and then proceeding with an acquisition of another property (also qualified) within a specific time frame. Investors exchange properties to avoid paying capital gains tax on any gains realized from the sale of a property. 1031 exchanges are also known as a tax deferred exchange.

How does a 1031 exchange work?

In a 1031 exchange, the exchangor (seller) who has a realized gain never touches the funds once escrow is closed with the buyer. Instead, the money is held with a Qualified Intermediary (aka QI, accomodator, etc.) until an exchange property is identified. The exchangor has 45 days after the close of escrow of the sale to identify several properties as potential exchange prospects.

Theoretically, the QI should hold such funds in safe, interest bearing accounts such as money market or treasury funds. However, LandAmerica decided to get cute and invest in "illiquid auction rate securities". I'm not sure what these illiqid securities are, but just the fact that QI's were able to invest the exchange funds freely is ridiculous.

Who is Land America Financial Group (NYSE: LFG)????

According to Google Finance:

"LandAmerica Financial Group, Inc. (LandAmerica) is a holding company and operates through its subsidiaries. The Company’s products and services facilitate the purchase, sale, transfer, and financing of residential and commercial real estate. These products and services are provided to a broad-based customer group, including residential and commercial property buyers and sellers, real estate agents and brokers, developers, attorneys, mortgage brokers and lenders and title insurance agents. The Company operates through approximately 700 offices and a network of more than 10,000 active agents, and conducts business in Mexico, Canada, the Caribbean, Latin America, Europe and Asia. Its principal business operations are organized under three operating segments: Title Operations, Lender Services and Financial Services. In August 2007, LandAmerica announced the acquisition of Chisholm, Nurser & Partners Limited (CNP), a United Kingdom-based independent building and project consultant."

Land America, at its heyday, offered just about every real estate related service you can imagine, ranging from title insurance to financing. They generated $3.7 billion of revenue in 2007 and were lauded as one of Fortune's "Most Admired Companies" (in fact, they promote this fact all over their website).

However, as of this post, I believe they are about to go Bankrupt. With real estate transtactions down and what seems to be miscalculated investment ideologies, Land America has been praying for a buyout by Fidelity National Financial Inc. (NYSE: FNF.N). But Fidelity backed off from the purchase and Land America's stock price dropped about 80% to close at $0.91 per share.

I just hope that Land America's 1031 clients will get some recourse. There is probably hundreds of millions of dollars frozen in Land America's QI accounts.

What can you do to protect your exchange?

In order to protect your assets in an exchange, don't choose your QI based on fees alone. As QI's are not regulated very closely, there is a large discrepancy of quality. Questions to ask include:

• How many years have you been administering 1031 exchange transactions?
  
  
• How many 1031 exchanges have you administered (individual 1031 exchange officer and 1031 exchange Qualified Intermediary)?
  
  
• Do you maintain fidelity bond insurance coverage to insure against employee theft, embezzlement or misappropriation of the 1031 exchange funds?
  
  
• What is the policy limit of your fidelity bond coverage?
  
  
• Is your fidelity bond coverage “per occurrence” or merely “in aggregate”?
  
  
• Will you provide me with copies of your insurance binders and the contact information for your insurance agents so I can verify that your insurance coverage is still in full force and effect?
  
  
• Do you maintain sufficient errors and omissions (E&O) insurance coverage to insure against any 1031 exchange Qualified Intermediary error or omission?
  
  
• What is the policy limit of your errors and omissions insurance coverage?
  
  
• Do your fidelity bond and errors and omissions (E&O) insurance policies cover just the 1031 exchange Qualified Intermediary or do they also cover numerous other related entity operations that might diminish the overall protection to me in the event of multiple losses throughout the consolidated entity such as title insurance, escrow, etc.?
  
• What type of internal processes and internal audit controls have you implemented to protect my 1031 exchange assets?
  
• Do your 1031 exchange administrators call me prior to the disbursement of my 1031 exchange funds to ensure that I want the funds disbursed (as opposed to disbursing when escrow calls).
  
• Where are my 1031 exchange funds held or invested?
  
• What type of specific investments do you use for my 1031 exchange funds?

-ML