Tenant-in-common (TIC) 1031 exchanges, private placement deals heavily hyped to financial advisors during the real estate boom, are drawing action by state and federal regulators.

These deals have been promoted as a turnkey way for an investor to defer taxes on the sale of an investment property via a "1031 exchange." Typically arranged through a sponsor, "TICs" let investors purchase fractional interests in a property-often office or retail buildings, taking advantage of this tax-friendly IRS rule.

Under Internal Revenue Code Section 1031, an investor can defer a taxable gain on the sale of a business or investment property by exchanging it for another of "like-kind."

"There have been troubling allegations of fraud in connection with the activities of the promoters of those tenancies in common offerings," says Denise Voigt Crawford, president of the North American Securities Administrators Association and Texas securities commissioner. "It's very important for investment advisors to make sure there is full disclosure about any such offerings and that investors realize these types of investments are highly illiquid. This means the investor has to be able to assume the risk of that investment for an indefinite period of time.

"If an investment advisor does not have the kind of background necessary to make good recommendations as a fiduciary, the investment advisor needs to seek out expertise."

Fueling regulatory concern: allegations of fraud, FINRA arbitration complaints and consumer lawsuits. In addition, there have been bankruptcy filings involving at least two multi-million-dollar national TIC sponsors-retirement home operator Sunwest Management Inc., of Salem, Ore., and DBSI Inc., of Boise, Idaho.

The Oregon Department of Consumer and Business Services on January 25 issued a cease-and-desist order against Sunwest owner Jon M. Harder of Salem for numerous securities violations. The state claims Harder misstated information or omitted facts when soliciting investors and violated Oregon securities laws by not registering the securities or investments and using unlicensed salespeople. The Securities and Exchange Commission also charged Sunwest Management with securities fraud and sought an emergency court order to freeze its assets. The SEC case was pending in U.S. District Court in Eugene, Ore.

Harder's Portland, Ore.-based attorney, Stephen F. English, says that although Harder can no longer have an ownership interest in a company that raises money from investors, he still can be in the senior living facilities business. And in the SEC case, his client is not admitting intentional fraud. But he has agreed not to oppose a claim that he was reckless in his representations to prospective investors concerning one of its senior living facilities. 

Court action was pending against DBSI Inc.

Marilyn Chastain, bureau chief of the Idaho securities bureau, says her state district court case in Boise was pending action on DBSI Inc.'s Chapter 11 bankruptcy case in Wilmington, Del. Her department had alleged that defendants associated with DBSI Inc. misrepresented that their real estate investments were essentially guaranteed; misrepresented terms of the loans on the property; failed to inform investors that their investments were widely considered to be a security-not a real estate transaction; and failed to inform investors that the investment required ongoing new sales and could collapse if sales ceased.

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