State Law & 1031 Facilitators
In the past, we’ve touched on various issues related to state taxation of 1031 exchanges. For instance, in our post on New York State, we mentioned the requirements which pertain to state tax withholding, tax forms, and the layers of tax which can apply. We’ve also discussed the unique case of Pennsylvania. As you may recall, Pennsylvania doesn’t recognize the provisions of IRC Section 1031 at all. Consequently, the sale of PA real estate will trigger state income tax in every case; there are no exceptions to this rule. As we’ve discussed in an earlier post, Pennsylvania essentially sees “delayed exchanges” as legal fictions, things which the tax code was never really meant to provide to begin with. This is the reasoning underlying its state tax policy.
States have also started to promulgate their own regulations on 1031 exchange facilitators (or “qualified intermediaries”). Right now, the federal government doesn’t regulate exchange facilitators. That may change in the future. But, until that happens, states have stepped in and designed their own exchange facilitators regulations to protect their consumers.
In this post, we will discuss the state regulations which have been passed on 1031 exchange facilitators. As of right now, our own State of New York hasn’t yet developed regulations on facilitators. This means that New York State facilitators have few requirements to comply with. At some point, however, this situation will probably change. New York will likely implements its own state regulations in future. And when that happens, New York State will most likely base its regulations on the regulations on some other state. Accordingly, let’s take a closer look at various state regulations of 1031 facilitators.
States with Regulations on Section 1031 Exchange Facilitators
Currently, there are a total of 8 states which have their own legislation regulating 1031 exchange facilitators. This number may seem surprisingly low, but the truth is that the 1031 industry is still relatively new. And among those who know about the industry, not many have an advanced understanding of its development. Most assume that it’s more regulated than what is actually the case.
Eight States Regulating 1031 Facilitators
The 8 states with regulations are as follows: New Hampshire, Virginia, Washington, Nevada, Idaho, Colorado, California and Maine. In these states, 1031 facilitators needs to comply with both the applicable federal laws and regulations and also the applicable state regulations. As we know, delayed exchanges are governed by the Treasury Regulations. And these federal regulations spell out certain requirements for 1031 facilitators. But if a facilitator wishes to conduct business in one of these states there’s an additional layer of regulations. And failure to comply with the state regulations will carry stiff consequences.
Commonalities Between State Regulations
The Treasury Regulations put few restrictions on 1031 facilitators. One of the main restrictions pertains to who is eligible to be a facilitator. But beyond this, there are few barriers. This is why these states have stepped up and promulgated additional rules. So what sort of regulations have these eight states issued? The regulations of the eight states vary in their specifics, but there a few things they have in common. For one, they all touch on the issue of bonding and insurance. Bonding and insurance requirements form a layer of protection for consumers of Section 1031 like kind exchanges. Suppose a 1031 facilitator decides to run off with a taxpayer’s funds; or, suppose funds are lost due to employee error or omission. These are the types of situations which are addressed with bonding and insurance. The states require minimum levels of coverage in order to provide security for consumers.
In addition to bonding and insurance, most of these states also address the type of account 1031 facilitators must use to hold client funds. In the State of Washington, for instance, 1031 facilitators must hold client funds in a “qualified trust account” unless they have certain levels of coverage. Again, this provides additional security for clients.
A Closer Look at Nevada’s State Regulations
One state worthy of mentioning separately from the other states is Nevada. Nevada stands out from the others because it is the only state which requires 1031 facilitators to have a license. Nevada’s legal code spells out the procedure for obtaining a 1031 facilitator license. This procedure is obviously specific to the State of Nevada. Nevada also requires that 1031 facilitators carry minimum levels of coverage (for fidelity bonds and insurance). What’s more, Nevada places regulations on where funds are held by its 1031 facilitators. Nevada requires 1031 facilitators to hold the funds of each client in a separate account. This is to prevent commingling of funds. Aside from the licensing requirement, these other regulations are typical and are found in the laws of the other seven states that regulate 1031 facilitators.
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When New York State develops its own regulations, they’ll likely cover the same basic issues addressed by the eight states referenced in this post. Future regulation of New York’s 1031 facilitators will likely cover bonding and insurance requirements, licensing, professional conduct and education requirements, among others. At Mackay, Caswell & Callahan, P.C., we stay up-to-date with the various areas of tax that we cover. As soon as New York passes legislation on 1031 facilitators, we’ll follow up on this post asap. If you’re preparing to conduct a 1031 like kind exchange in the near future, hiring a qualified tax attorney may be a good investment. Feel free to reach out to one of our top New York City tax attorneys for assistance today.
Image credit: Woody Hibbard