Disclosure:  Easy on Sale, Not on Purchase 
 

We also note that the input we requested has not yet had time to form. We will post any significant responses or additions. Readers are invited to give such input through our e-mail.

Over the past few years we have had some reluctance on the part of a few Brokers in Arizona when our exchange clients have not wished to disclose the potential for the exchange on offers made for replacement property. The purpose of this letter is to discuss the background of this issue, the tax law, the consequences of premature disclosure and non-disclosure and to invite the local Realtor community to respond where our knowledge may be deficient. The goal is to combine to form a proper, well-rounded, legal and client-serving response to this issue. Perhaps you could help this find its way to an appropriate forum?
 After an evaluation of the response, the combined information will be posted to our Website and all of the country will hopefully benefit from a well-though-out and supportable policy to draw from in this issue of disclosure. The Prescott Realtor community and our firm will combine to be on the cutting edge of an area not well understood around the country.

Background

The Internal Revenue Code and the Regulations under Section 1031 never specifically require disclosure or cooperation from the non-exchanging party (buyer or seller). They effectively require disclosure and cooperation as the Intermediary must be assigned the taxpayer's interest in the escrow at hand. This can not happen without the cooperating party's knowledge and consent and so disclosure is a given at some time prior to close of escrow. The law requires this before the close of escrow and does not specify any other requirement, such as when disclosure must be made. When representing a seller, there is no reason not to disclose the presence of the exchange and elicit cooperation from the start. Disclosure on the sale side presents no problem whatsoever for the seller or the buyer. There exists a very different situation for representation of buyers in an exchange.

Consequences

When making an offer, if the existence of the exchange is disclosed, the knowledgeable seller may reasonably assume that the buyer has some significant tax consequences if the buyers do not end up closing. This is information which is strictly confidential and can be damaging to the buyer's negotiating position. For example, when those last little negotiations occur (which they invariably do just before close) knowledge that the non-closing would be very costly to the buyer could seriously weaken the buyer's negotiating position.

Some important points of review

1. For an outside CPA or attorney, such personal tax information is held under the strictest confidence and release of that information violates both profession's standards. The question then stands: Is the real estate community able to disclose personal tax information that the client's own tax and legal advisors can not? It does not seem that this would be proper. Would it be ethical to call the sellers tax preparer and inquire about their tax consequences upon a sale? If the answer is (a resounding) "No," then how could it be proper to simply give this same kind of information away at the outset?

2. In a standard tax-deferred exchange, the non-exchanging party has no costs, delays or any other ramifications that would affect them as a result of the exchange. Their deal is their deal whether an Intermediary is present or not. This is very important, because if that were not so, we would obviously have an affirmative requirement to disclose anything that could have a negative impact. An exchange has no impact on the other party and therefore disclosure can do nothing but undermine the buyers negotiating position.

3. Presentation of offers with the offeror ending in "or Nominee" will preserve the right of the offeror to substitute the Intermediary prior to close of escrow, but will not necessarily reveal any confidential information.

4. An exchangor has no obligation to any party to complete the exchange they may have started. They have an obligation only to fulfill their purchase contract as it is written. They may have new tax circumstances arise (like a capital loss) or there might be a variety of other circumstances that will render the exchange useless. They are free to make that choice as to how they will structure their tax picture at any time up to and even after closing. How can there be an obligation to disclose when there does not even exist the obligation to finish an on-going exchange in the first place? Disclosure will be required prior to close if the client wants to properly complete one, but up until that time, the client should be allowed full flexibility to complete or dispense with their exchange without suffering the negative impact of early disclosure.

5. A common sense approach aside from the confidentiality aspect would be illustrated by these questions: Would a Realtor representing a buyer, tell the seller's agent that the buyers are hopelessly in love with their property and would be glad to pay well above what the stated offer was? Of course not. This may be the absolute truth, but disclosure of such personal information would not be in the best interests of the client. Similarly, does the duty to disclose information which has essentially no effect on the other side surpass the duty to protect the client's interest by simply preserving confidentiality? We would have to say "no."

It has been our counsel to our clients that they make offers in their own names plus "or Nominee" and once the significant contingencies are passed, disclosure is made to allow the sellers and the title company to complete those minor changes required to fulfill the law concerning exchanges. A caveat here, we don't want to let our clients get into a position that all contingencies are cleared including the stated closing date and then disclose the exchange. Courts have ruled that having no disclosure with all elements of closing present could negate an otherwise valid exchange. The simple solution: disclose as soon as the risks of further negotiating points are passed, but with enough time to make changes in escrow in an orderly fashion and certainly prior to the stated date of closing.

Knowing the potentially dire consequences of disclosure too early, we are not familiar with the professional ethics and legal requirements of the Realtors and humbly request any input in this area to deal with both requirements and continue to protect the interests of our mutual clients. It may well be that we are ignorant of some important tenent of the Realtors code of ethics and need education. We genuinely welcome that opportunity.

Please call us at 1-800-270-1031 and we will be grateful for any response.

Sincerely,
B P & A Holdings, Inc.

Bradley S. Penner, CPA
President