Opportunties For CUs Are Seen In '1031 Exchange' Plans

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Do you know what a 1031 Exchange is?

Some people do. And they believe they hold great opportunities for credit unions.

Two such proponents, Peter Paulson, EVP with Corporate America Family Credit Union, Elgin, Ill., and Elizabeth Hayes, SVP with Affinity Plus FCU in St. Paul, Minn., both of whom are members of the Filene Institute's i3 Project (Ideas, Innovation, Implementation), a hand-selected group of people identified as the "next generation" of credit union leaders. During the NACUSO CEO Collaborative in Kansas City they previewed an i3 idea they hope to take mainstream.

"Not many outside the mortgage or tax business may know what a 1031 Exchange is, but it offers something for your credit union and your members, especially those who are investing in real estate; even those buying commercial properties," said Hayes, who previously was in banking prior to joining credit unions.

Named for Internal Revenue Code Section 1031, a 1031 Exchange offers the opportunity to defer, or possibly eliminate, capital gains tax if the property is exchanged for other property within a set time frame, she explained. Hayes then showed the difference the 1031 Exchange can make on a $200,000 transaction, which resulted in the member saving $56,000 in tax.

After the sale of the property, the money is held in escrow by an intermediary for up to 180 days before being applied to the purchase of the new property. But the bonus for the credit union is even more lasting then the sale-to-market fee (1%) and the closing costs with the CU title company (estimated at $1,500) and the fee for the 1031 service (between $500 to $1,500). "Members will see the credit union as a reliable source of finance. The credit union gets the mortgage, expands its real estate lending capacity, increases mortgage volume and attracts new members," she said.

"Some members form LLCs to protect their personal assets," Hayes noted, pointing to the hot real estate market, including the Twin Cities, and the outflows from the equities market. "As the business grows, credit unions can join a CUSO partnership and act as intermediaries."

Intermediaries are typically CPAs or law firms, but there is no restriction and virtually no regulation of that area of the business. But a credit union cannot be an intermediary; that must be a disinterested party, so a CUSO can fill that role because it is not the lender, and therefore not involved directly in the transaction.

"The intermediary must be independent and not related to the transaction," said Hayes. The kinds of "property" involved in this kind of transaction aren't limited either. "Real property can be farmland or it can be an airplane," she said.

Affinity Plus is looking at this idea the same way it considered forming its own title company. As the title business grew, it partnered with LandAmerica (a large national title company) and later moved the entire operation in-house.

In response to one credit union's question about the credit union's liability of being seen as an advisor, Hayes answered that they use different underwriting criteria than for primary residence loans. "We never go to 100% loan-to-value and secure two months of reserves. Also, members who engage in this kind of investment are typically very sophisticated."

Nevertheless, Hayes urged caution. "We have a cap on the number of properties (10) and limit the number done each year. It's a low-risk, high-return if you do the due diligence, and that's what we're all about, isn't it?"

Paulson told attendees that this kind of transaction isn't limited to the very rich, but is within the range of many members, typically two-income earners of middle age. "You may already be doing this; you're just not promoting it"-or, for that matter, benefiting. There were 219,000 exchanges in 2003 and there's the popularity of tenant-in-common (TIC) exchanges to consider, Paulson said.

The credit union can be seen as the trusted partner for this growing segment of the membership, he added. 'It may be right for you if you are already doing investment lending and offer business services."

To get started, a credit union might want to partner with an existing intermediary.

Later, a CUSO can be formed to apply as a QI to offer exchange services to other credit unions-to earn fee income and expand real estate services in the industry. QI agents must be independent of the transaction.

Paulson was asked if the NCUA had any problems with the idea. "We haven't had any dialog with the NCUA yet, and we don't think they'd be open to a hypothetical situation," he said.

Guy Messick, NACUSO's general counsel said he thought this was a doable thing. "Just be careful on the intermediary side. Many intermediaries are attorneys and CPAs, and you wouldn't want to upset any existing business relationships."

"This is an idea that's hot off the press right now. When we said innovation, we meant it," said Messick.

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