CU 1031: Project Summary
The Market Need
Credit unions need to capture more of the real estate market. Through mortgage-related products and services, credit unions have the ability to finance investment and vacation properties, commercial real estate and business services. However, they are not taking full-advantage of this virtually untapped resource.
Consumer real estate business is truly an untapped, even unexplored, market for credit unions, which account for less than 2 percent of total consumer real estate financing in the United States. Only 17 percent of all U.S. credit unions – including 52 percent of credit unions with more than $100 million in assets – offer member business loans. At the same time, credit union members in general are investing more often in commercial and investment real estate.
As real estate investing increases, so will property exchanges. Internal Revenue Code Section 1031 allows a consumer selling property the opportunity to defer, or possibly eliminate, the capital gains sales tax if he or she exchanges the property – through a qualified intermediary – for another property. The average capital gains sales tax is between 15 and 30 percent of the sale value, so a 1031 exchange can provide a substantial savings.
In 2003 alone, there were 219,000 exchanges in the United States, an increase of 27 percent over 2002. Competition is lighter in this real estate service niche and is comprised of either large national title insurance companies or small, qualified intermediaries operating in local markets. The business potential is large, however. In 2004, for example, one national company (Investment Property Exchange Services, Inc.) processed 22,000 exchanges.
The 1031 Exchange is an astute option for consumers looking to put cash in hand, relocate properties, diversify investments, and/or take care of retirement or vacation home considerations. However, the IRS requires consumers to facilitate the property exchange through a qualified intermediary that holds and manages the exchange funds during the exchange period.
The Solution
Credit unions have long been known as trusted advisors that focus on consumer education. Transitioning that trusted advisor status into real estate transactions – as qualified 1031 intermediaries – could give credit unions a unique foot in the real estate door. CU 1031 allows the credit union to become the trusted advisor in the 1031 exchange.
Implementation: To make a tax-free property exchange, a consumer must exchange “like kind” real property, such as land, rental or business property for other land, rental or business property. The consumer has 45 days to identify the replacement property and 180 days to complete the transaction. The exchanger must also use a safe harbor (qualified intermediary) to hold the funds from the first property sale and then facilitate the exchange.
As that safe harbor, CU 1031 accepts completed forms submitted to it by the member or an escrow officer. The member enters into an exchange agreement with CU 1031, signing an amendment to the escrow that names CU 1031 as the seller. When escrow closes on the relinquished first property, proceeds go directly into the guaranteed account established by CU 1031. At this time, CU 1031 sends a letter to the member advising them of the amount of proceeds and the IRS deadlines for exchanging property. The member sends CU 1031 written identification of the new property they plan to purchase in the exchange, and sometime within 180 days of the initial property sale, the member enters into an agreement to purchase replacement property. He or she then signs an amendment that names CU 1031 as the buyer of that second property. After closing on the replacement property, CU 1031 provides final accounting to the member, who then files IRS Form 8824. Credit unions also provide 1031 education and marketing to this niche group and the community through seminars, etc.
Credit union income will be generated from two alternative sources: fees for the service, which range between $500 and $1,000 depending upon complexities, or referral payments of a projected 25 basis points for any loans resulting from the 1031 exchange business. If the loan is held by the credit union then the transaction will produce interest income.
Credit unions in the best position to implement CU 1031 will be those located where the volume of investment property is modest or increasing. Memberships that especially favor such a program include those with a significant segment in the prime commercial real estate and 1031 exchange demographics (those who are over the age of 45 and whose average household income is $85,000 or higher). Ideally, i3 concluded, a credit union interested in offering CU 1031 should have an established credit union service organization – with a real estate focus – that is looking to provide ancillary services through a CUSO or a partnership with an existing qualified intermediary.
The Benefits
CU 1031 provides a service avenue for credit unions into a small niche of upscale investors and also positions the credit union as a mortgage and business lending and services source in the community. The service also increases the credit union’s reputation as a trusted advisor and financial educator, especially in an industry segment that is complicated and less regulated.
The membership niche taking advantage of the CU 1031 services will appreciate that their credit union guided them through the 1031 process and helped them maximize their investments and minimize their tax responsibilities while diversifying their investments.
The First Step
To become a trusted advisor in the commercial real estate market, explore details of the CU 1031 concept in the i3 section of this Web site or by calling 608.231.8550. Receive additional updates on this and other i3 innovations by becoming a Filene Research Institute member.
