There are significant tax reporting challenges involved when an investor sells relinquished property and structures a 1031 Exchange in order to defer his or her taxes by acquiring a like-kind replacement property and then having the Qualified Intermediary fail. 

Revenue Procedure 2010-14 was issued today by the Internal Revenue Service to help investors that were affected by 1031 Exchange Qualified Intermediaries that failed to complete the investor's Like Kind Exchange by acquiring and transferring replacement property to the investor.

The Rev. Proc. 2010-14 provides a safe harbor method of treating and reporting capital gain or loss for certain taxpayers who initiate tax deferred exchanges under Section 1031 of the Internal Revenue Code but fail (default) to complete their 1031 Exchange because their Qualified Intermediary has failed to acquire and transfer like kind replacement property to the investor.

The Internal Revenue Service will not treat investors that meet the requirements of Rev. Proc. 2010-14 as being in actual or constructive receipt of their 1031 Exchange funds when the investor did not complete his or her 1031 Exchange because of their Qualified Intermediary (QI) defaults and becomes subject to a bankruptcy or receivership proceeding.

There are more questions this year because many taxpayers sold real estate and cashed out rather than deferring their taxes via a 1031 Exchanging again.  They now have significant income tax liabilities to worry about.

Depreciation Recapture Issue

The one tax planning issue in terms of rental or investment property that is most often misunderstood by taxpayers is that of depreciation recapture.  Depreciation, or writing off the cost of a building, is mandatory if a taxpayer buys and holds rental or investment property. 

The depreciation is indefinitely deferred into the future upon sale of the investment property as long as the taxpayer structures a 1031 Exchange transaction.  However, the depreciation will be recaptured and taxed upon the sale if the taxpayer does not 1031 Exchange into replacement property.

This is the reason that we have noticed an increase in depreciation recapture questions.  So, I thought that I would link to a discussion board post on depreciation recapture that will help explain the issue in greater detail. 

1. "Fundamentals will remain 'choppy' in the first half of the year, with conflicting data points making it difficult to ascertain whether we’ve actually reached the trough in housing."
2. "Headline risk, primarily driven by the government's efforts to extract itself from the mortgage market, will drive the homebuilding stocks down 15% or more from current levels…With the longer term path for fundamentals offering limited clarity, we expect the homebuilding stocks to remain quite volatile and extremely sensitive to news flow."
3. "The previous prediction notwithstanding, the government is going to do everything in its power to protect home prices...In the end; we believe that concerns about higher rates and declining mortgage market liquidity won't amount to much. In our opinion, the government continually made it clear that it is working to limit further home price declines given the serious ramifications these declines would have for both consumers and lenders."
4. "Although we forecast that as many as 7 million foreclosures are likely to occur over the next several years, we believe the pace at which these homes will come to the market will be consistent with current levels. As such, the concerns around the negative impacts of rising inventory levels are overdone."
5. "An improvement in unemployment is the single most important predictor for the longer term health of the housing market - only by focusing on this variable can we truly understand the timing for a recovery."
6. "An improving jobs picture will d4rive greater price stability and better demand. That said, given the level of excess inventory, the pace of price appreciation will be below trend for some time."
7. "The builders will see sequential improvements in their quarterly results."
8. "Given the limited amount of high quality, finished lots coming to market, we expect the builders to increasingly consider purchasing undeveloped parcels, which represent a greater value. This trend will be magnified if conditions start to accelerate more meaningfully in the near term as builders look to rebuild their operations over time."
9. "Although residential construction lending standards might loosen in 2010, liquidity will be insufficient to drive starts toward current consensus estimates."
10. "The longer term outlook for housing will increasingly dominate investors focus toward the end of 2010."

The Center is a non-profit founded by a group of like-minded professionals. We recognize that business families fill a vital role in building and funding the broader community, and our communities depend upon their energy and contribution. Today’s business families are faced with unprecedented challenges. A recent study by nationally recognized family wealth consultants Roy Williams and Vic Preisser indicates that 70% of financially successful families fail to pass their business and wealth even one generation. Much of this failure comes from a breakdown of trust and communication within the family or a failure to adequately prepare their heirs.

Our commitment via The Center for Wealth & Legacy Studies is not to just report on the issues, but to provide practical guidance on all matters of wealth and legacy. Through a variety of media and forums, The Center for Wealth & Legacy Studies™ provides objective clarity, expertise and perspective to local, national and international audiences.

Blue Ocean Strategy is a framework for innovation and business dominance developed and outlined in the best-selling book Blue Ocean Strategy: How to Create Uncontested Market Space, by W. Chan Kim and Renée Mauborgne (Harvard Business School Press 2005). While the concept of finding an untapped market to dominate is as old as business itself, the two INSEAD (Institut Européen d'Administration des Affaires) professors have created a worldwide sensation by boiling it down to a corporate way of life. And, in a recent interview with Forbes India, Professor Mauborgne stated emphatically that in the wake of the financial meltdown of the last two years, "it is more imperative than ever for companies to shift their attention and efforts... [from] dividing existing demand to creating new demand in order to embark upon the path of profitable growth and lead themselves and the world out of the crisis." So this remains cutting edge business theory for your clients. Pocket MBA encourages you to pick up a copy of the book, or you can learn a lot just by visiting the Blue Ocean website. The book and strategy are a result of studying "150 strategic moves spanning more than a hundred years and thirty industries."

In brief, what is a Blue Ocean Strategy for success? How does a company go from making widgets fighting a dozen other widget makers tooth and nail for market share to being an Apple, Cirque du Soleil or Gillette, which as the authors of the book would say, have fans, as opposed to customers? How does a company know if it is already operating in a blue ocean as opposed to a red ocean filled with the blood of it and its competitors? The first thing to remember is that the "aim of BOS is not to out-perform the competition in the existing industry, but to create new market space or a blue ocean, thereby making the competition irrelevant."

For a company to determine where they stand currently, the authors pose a list of questions. Answering "yes" to all or most means you are a red ocean company. The questions range from "Is your company focused more on cost cutting, quality control, and brand management at the expense of growth, innovation, and brand creation?" to "Do you blame your slow growth on your market?" to "Are mergers and acquisitions the principal means your company sees to grow?" Finally, they instruct companies to list their "key competitive factors" along with those of their competitors. If they are the same..., well, you get the idea.

A blue ocean strategy is simply one that gets you out of that paradigm where the answers to all the questions are "yes." Often easier said than done, and some companies do it by accident. In fact, that is historically how it has happened. What BOS does is to systematize what is otherwise done unconsciously. Everyone wants to bust out and lead the pack, but if you don't see an obvious opportunity, you fall back into the same routine of scraping for market share. Sometimes it's as simple as looking at the market for a company's product in a different light: "By questioning conventional definitions of who can and should be the target buyer, companies can often see fundamentally new ways to unlock value."

Thus Cirque du Soleil, a feature on the BOS website, took the concept of circus ("you get the kids; I'll get the car...oh, look a sad clown...zzzzzzzzzz") and recreated it by targeting a new audience (adults and corporate) with updated- and technologically-advanced versions of the same stuff you'll see at Ringling Brothers. You cannot go to a show by Cirque du Soleil and not leave thinking you've seen something completely different. And yet, if you look at the fundamentals — tumbling, tightropes, trapeze, clowns — it's still a circus. But you can be sure that PMBA will be at the next Cirque du Soleil show in NYC, even though it wouldn't think about going to the traditional circus. (Worst birthday present PMBA ever received? Tickets to the regular circus for birthday number 24.)

Pocket MBA can't convey much more without violating BOS' intellectual property. But there is apparently no industry that isn't ripe for a BOS. The BOS website highlights the transformation of the New York City Police Department as having executed a BOS as it transformed New York from a notorious crime center to a place where you have to be pretty unlucky to get mugged. So while we focus on BOS for companies, who knows, it may be possible for a law firm to create a blue ocean. PMBA hasn't thought that out yet; then again, PMBA doesn't have a firm. But you do. Maybe it's time to take a dip in a different ocean.

Reprinted from a PLI newsletter: About Practice Law Institute (PLI)

PLI is a non-profit continuing legal education organization dedicated to providing the legal community with the most up-to-date information available. Founded in 1933, PLI's continuing mission is to enhance the professionalism of attorneys and other qualified persons by providing, in a cost effective manner, the highest quality and most innovative programs, online CLE, publications and other services to enable them to practice law competently and ethically, and to fulfill pro bono responsibilities. We offer more than 250 programs annually in locations across the U.S., including live webcasts, specialized in-house training programs, interactive multimedia, web programs, course handbooks and annually supplemented treatises. In addition, PLI annually awards over 3,000 full and partial scholarships to our programs. Learn more about PLI at www.pli.edu.

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The ISM Manufacturing Index rose to 55.9 from 53.6 in December, beating expectations and marking the fastest expansion since April 2006. New orders hit a high of 65.5 and the orders/inventories gap widened anew to 22.1. Readings should be supportive of healthy growth in industrial production in the coming months.

Pending home sales fell a sharp 16% in November, providing strong proof that the home buyer tax credit boosted sales earlier in 2009. The credit was set to expire on 11/30, but has since been extended. Therefore, sales were likely accelerated in anticipation of the expiration.

Factory orders rose a larger-than-expected 1.1% in November. This was primarily driven by orders of nondurable goods, most likely reflecting the higher prices of petroleum products. The data on inventories and capital goods shipments increases upside risk to our 4% Q4 GDP estimate.

The ISM Non-Manufacturing Index disappointed expectations, rising to only 50.1 in December, only slightly above the 50-point dividing line between growth and contraction. Of the four component indices, the most forward-looking new orders index slipped 3 points to 52.1.

Nonfarm payrolls fell 85k in December after a positive, but in consequential, revision from -11k to +4k the previous month. However, the household survey was considerably weaker. While the unemployment rate remained flat at 10% in December, the labor force and employment dropped sharply. At 64.6%, the labor force participation rate is at its lowest level in 25 years. With part of this drop likely to reverse in coming months, job growth will be needed to keep unemployment from rising.

November’s unchanged reading broke a string of seven consecutive increases for the USD Index.  There is no change though in the previously reported outlook for 2010.  The first few months of the year may be weak, with the local unemployment rate edging up to approach 11 percent.  Things will improve in the second half of the year, with a net overall gain of between 3,000 to 5,000 jobs for the year.  An improving housing market will boost employment in construction, while research and development and health services will remain relatively strong.  Rebounding local and national economies will stabilize employment in retailing and in the leisure and hospitality sector.  However, job losses are expected to continue in manufacturing, which has lost jobs in 10 of the last 11 years.

The Center for Wealth & Legacy Studies earlier announced its expansion into the Las Vegas, Nevada market with the launch of its first Wealth & Legacy Seminar in Las Vegas to be held on Wednesday, January 20, 2010. 

The Wealth & Legacy Seminar Series will now be offered in both Las Vegas and in its original venue of San Diego, California.  The Center's next San Diego Wealth & Legacy Seminar is Wednesday, January 27, 2010. 

I can't get financing to grow my business.  No one is lending.  No one is investing. 

However, there is capital out there.  There is capital available to the small closely held business, but you have to know where to go and where to look to obtain it.  You must be prepared to look outside the box, and you may have to give up some equity ownership. 

Join us at our next Wealth & Legacy Seminar this month.  We will be addressing exactly this same issue of where and how you can get financing or capital for your closely held small business.  The Wealth & Legacy Seminar is entitled "Just Show Me The Money." 

We hope to see you there.