<p>The Virginia state legislature has approved a new law governing the activities of qualified intermediaries and the state's governor, Bob McDonnell, has signed the act into law. The Virginia Exchange Facilitator Act (Virginia House Bill 417) is patterned largely after the Federation of Exchange Accommodators Model Act and will become effective on July 1.</p>

<p>You can review the text of the <a href="/sites/default/files/Virginia.pdf__M.pdf" target="_blank">Virginia Exchange Facilitator Act</a> here. You can also find important information on other state and federal regulations that may affect your business by visiting our <a href="/resources" target="_blank">Resource Library</a> page.</p>

<p>As we reported last week, <a href="/blog/update-california-1031-provisions-dropped-official" target="_blank">California has decided</a> to <a href="/blog/california-reconsider-anti-1031-provisions" target="_blank">eliminate all the provisions within AB 2640 targeting Like-Kind Exchanges (LKEs)</a> in the state. This is good news, as these provisions were particularly unfriendly to businesses that currently, or will someday, employ qualifying exchangeable assets. In short, the measures would have eliminated the enormous benefits of LKEs in California. From an economic standpoint it makes sense to keep LKEs working for the state as their use allows a very large number of businesses to participate in a virtuous cycle of business transactions. LKEs immediately and efficiently reinvest dollars back into company operations, impacting not just their employees, but the overall health of the marketplace, too.</p>

<p><em><strong>Given these tough economic times, taking LKEs off the table would have resulted in slower expansion, lost jobs and decreased tax rolls. Additionally, the absence of LKE treatment for older assets would have been harmful to the environment.</strong></em></p>

<p>The Environmental Protection Agency (EPA) is charged with the oversight of emissions standards in the United States, but it's not the only authority states look to when determining what standards to follow. California's Air Resources Board (CARB) issues more stringent standards and many states choose to follow CARB standards rather than the EPA's. Furthermore, California's large marketplace gives it significant leverage in dealing with automakers, heavy equipment manufacturers and energy utilities. This enormous market leverage allows California to dictate environmental requirements to a wide array of businesses wishing to enter and stay within the state's competitive arena.</p>

<p>As you can imagine, staying competitive and environmentally friendly is expensive, especially in California. In recognition of this, CARB offers a variety of incentives, which include:</p>

<ul>
<li>Grant programs for clean on and off-road vehicles</li>
<li>Equipment grant programs</li>
<li>State financing programs</li>
<li>Emission credit programs</li>
</ul>

<p>These are all great ideas, but the sale of old, environmentally unfriendly generators, vehicles and other equipment may still trigger a large tax liability. This is why LKEs are so very important, not just from an economic benefit standpoint, but (especially in California) from an environmental benefit standpoint as well. By leveraging state and federal incentives with LKEs, companies can more quickly convert from:</p>

<ul>
<li>Fossil fuels to wind, solar and hydroelectric power</li>
<li>Energy inefficient to environmentally friendly infrastructure</li>
<li>Fossil fuel vehicles (including autos, heavy equipment, boats) to natural gas, electric, etc.</li>
</ul>

<p>The bottom line is that environmentally targeted incentives and credits alone cannot overcome the huge capital investments required to meet escalating air standards. California made the right decision to allow businesses to continue using LKEs. In doing so, businesses will be operationally incentivized to go greener much faster, and that's good for both the economy and the environment.</p>

<p><strong>First, let's consider eligibility. </strong>The revenue procedure applies to:</p>

<ul>
<li>Taxpayers who properly transferred relinquished property to a QI and</li>
<li>have properly and timely identified replacement property,
<ul>
<li>unless QI default occurs during the identification period.</li>
</ul>
</li>
<li>Taxpayers who were unable to complete the exchange solely because of the QI default and the QI
<ul>
<li>then becomes subject to a federal bankruptcy, or</li>
<li>receivership proceedings under federal or state law.</li>
</ul>
</li>
<li>Taxpayers who have not had actual or constructive receipt of
<ul>
<li>the proceeds from the sale of the relinquished property, or</li>
<li>any other property of the QI prior to the date the QI enters bankruptcy or receivership proceedings.</li>
</ul>
</li>
</ul>

<p>As you can imagine, a number of taxpayers have been holding their collective breath hoping for some good news on this situation.</p>

<p><strong>The second consideration is reporting. </strong>Once the exchanger has determined that they meet the applicability test of the revenue procedure, an analysis must be performed on how to report the failed exchange.&nbsp; Thankfully, the revenue procedure also explains how this should be done. The application of the revenue procedure includes:</p>

<ul>
<li>Recognizing gain only as <u>payments</u> are received; this is good news, as the tax liability can be satisfied from payments received by the taxpayer, rather than from other sources.

<ul>
<li>This also allows the taxpayer to report the gain in the year the payment is received, rather than the year the relinquished property was disposed.</li>
</ul>
</li>
<li>Recognition of gain through the "gross profit ratio method."
<ul>
<li>The portion of any payment related to the relinquished property is multiplied by,
<ul>
<li>a fraction composed of the taxpayer's <u>gross profit</u> over the <u>contract price</u>.</li>
</ul>
</li>
</ul>
</li>
</ul>

<p>Definitions for proper reporting are:</p>

<ul>
<li><u>Payments</u> include: proceeds, damages, or other amounts related to the sale of the relinquished property.</li>
<li><u>Gross Profit</u> is defined as the <u>selling price</u> of the relinquished property, less the property's basis.
<ul>
<li>Any selling expenses not paid by the QI out of proceeds should be added to this amount.</li>
</ul>
</li>
<li><u>Selling Price</u> generally means the amount realized on the sale of the relinquished property.</li>
<li><u>Contract Price</u> is the selling price of the relinquished property less any assumed debt (by the buyer and not in excess of the adjusted basis of the relinquished property).
<ul>
<li>Assumption of debt in excess of basis is treated as payment, related to the relinquished property, in the year satisfied.</li>
</ul>
</li>
</ul>

<p><strong>Finally, as always, <em>consult your tax advisor</em>.</strong> Like all issuances related to the I.R.S., the actual <a href="/sites/default/files/Rev%20Proc%202010-14.pdf" target="_blank">RevProc 2010-14</a> document is much more detailed than the above overview and a comprehensive analysis should be left to a competent tax advisor - preferably one familiar with your specific circumstances.&nbsp; If you believe that you may qualify under this new revenue procedure, you should contact a tax professional immediately.</p>

<p>In some circles Accruit is known for the value it represents for businesses buying and selling investment property - that is, tangible real estate assets. However, Accruit's patented 1031 process - the only patented like-kind-exchange (LKE) process in the nation* - provides our clients with a level of efficiency that other providers simply cannot match. So when we talk about maximizing your gain and minimizing your risk and administrative burden, we're talking about businesses buying and selling corporate and commercial real estate, too - no matter what industry they're in.</p>
<!--break-->

<p>We've produced a <a href="/sites/default/files/Real%20Estate.pdf" target="_blank">Real Estate 1031 like-kind exchange fact sheet</a> that explains, in greater detail, how the process works, and we also provide a case study that illustrates the cash flow benefit that arises from a typical commercial real estate exchange. Have a look, and if you'd like more information on how an Accruit LKE might benefit your business take a look at our informational&nbsp;Real Estate Exchanges page or <a href="/contact-us" target="_blank">contact us</a>.</p>

<p><em>* U.S. Patent No. 7,379,910, and other patents pending.</em></p>

<blockquote>
<p>Some time back I posted a proposal arguing that <a href="/blog/unleashing-green-stampede-within-americas-energy-industries" target="_blank">Section 1031 of the tax code should be altered to provide oil and gas companies a "one-way swinging door" from fossil to green</a>. In a nutshell, the current tax code allows these companies to sell fossil development assets and defer recognizing the gain on the sale if they then reinvest in a "like-kind" asset. Like-kind, of course, means fossil. The code does not allow O&amp;G companies to use this powerful tool to shift their focus away from fossil and into green technologies.</p>

<p>Since the Obama administration has made the migration to sustainable energy a priority, the proposed modification to Section 1031 not only makes solid intuitive sense, it also sounds like a good idea to literally everyone we've talked to (a list that includes tax professionals, investors, lawyers, senior corporate leaders, oil and gas industry executives, journalists, academics and Congressional staffers).</p>

<p>As we continue seeking to draw more interested parties into this discussion, we thought it might make sense to have a similar look at another industry implicated by this strategy, coal. I charged Lauren McNitt (School of Journalism and Mass Communication, University of Colorado) and Wenting Zhang (Daniels College of Business, University of Denver), who are interning with Accruit for the summer, with taking a look at the coal industry, which is necessarily implicated in any meaningful attempt to green our economy. While there's no evidence that coal companies currently have an appetite for this kind of reinvestment (perhaps because they've never thought of it), it nonetheless makes sense to begin aligning the tax code with our long-term goals today. As the authors suggest, our shift away from coal is a matter of when, not if. - Sam Smith</p>
</blockquote>

<hr />
<h4>Overview</h4>

<p>The U.S. coal mining industry reaps $25 billion in annual revenue and is second in the world in terms of production. The top ten coal companies, such as Peabody Energy, Rio Tinto and Arch Coal control about <a href="http://www.eia.doe.gov/cneaf/coal/page/acr/table10.html&quot; target="_blank">65 percent of the industry</a>. The main customer of the mining companies is the electric utilities industry, which includes 2,200 plants and has a combined revenue of $80 billion. In 2008, coal accounted for <a href="http://www.eia.doe.gov/cneaf/electricity/epm/table1_1.html&quot; target="_blank">48.5 percent of electricity generated in the U.S.</a>. The fate of the U.S. coal mining industry relies on the electric utilities industry's continued use of coal.</p>

<h4>Coal: State of the Industry</h4>

<p>Coal power plants, which account for a <a href="http://www.washingtonpost.com/wp-dyn/content/article/2009/08/10/AR20090…; target="_blank">third of U.S. greenhouse emissions</a>, are facing a series of dilemmas as climate disruption and renewable energy increasingly occupy the attention of lawmakers. Earlier this year, President Obama signed an economic stimulus package focused on "greening" the U.S. economy. The <em><a href="http://greeninc.blogs.nytimes.com/2009/02/17/obama-signs-stimulus-packe…; target="_blank">New York Times</a></em> noted the following provisions in the bill:</p>

<ul>
<li>A large sum for energy efficiency, including $5 billion for low-income weatherization programs; over $6 billion in grants for state and local governments; and several billion to modernize federal buildings, with a particular emphasis on energy efficiency;</li>
<li>$11 billion for "smart grid" investments;</li>
<li>$3.4 billion for carbon capture and sequestration demonstration projects (sometimes referred to as "clean coal");</li>
<li>$2 billion for research into batteries for electric cars;</li>
<li>$500 million to help workers train for "green jobs";</li>
<li>a three-year extension of the "production tax credit" for wind energy (as well as a tax credit extension for biomass, geothermal, landfill gas and some hydropower projects); and</li>
<li>the option, available to many developers, of turning their tax credits into direct cash, with the government underwriting 30 percent of a project's cost.</li>
</ul>

<p>The emphasis on greening our economy continued with the introduction of a climate bill currently under debate in the Senate, <a href="http://energy.senate.gov/public/index.cfm?FuseAction=IssueItems.Detail&…; target="_blank">S. 1464: American Clean Energy Leadership Act</a>. The bill's sponsors hope it will create clean energy jobs, lead to U.S. energy independence, promote clean energy technology, reduce global warming and assist the transition to a clean energy economy. The House already passed its version of the bill (<a href="https://www.congress.gov/bill/111th-congress/house-bill/2454&quot; target="_blank">H.R. 2454: American Clean Energy and Security Act</a>).</p>

<h4>What legislators are ignoring</h4>

<p>The goal of these bills is to facilitate the transition to a clean energy economy, yet the legislation is missing a key provision that would encourage companies in the fossil fuel mining and utilities industries to begin a crossover to the renewable energy sector: a revision of the tax code to allow companies to employ 1031 Like-Kind Exchanges (LKEs) when transitioning from fossil to renewable energy assets.</p>

<p>The bills instead address the negative effects of the fossil fuel industry on the environment (in particular coal fired power plants) by proposing cap-and-trade policies. If passed, cap-and-trade will require carbon-emitting companies to buy permits that allow them to emit a specific amount of carbon. Companies looking to decrease the number of permits they buy may potentially invest in controversial carbon capture technology instead of investing in proven renewable energy technologies.</p>

<h4>CCS technology is not a long-term solution</h4>

<p>This presents a problem since, as reported in the <em><a href="http://www.washingtonpost.com/wp-dyn/content/article/2009/08/10/AR20090…; target="_blank">Washington Post</a></em>, carbon capture and sequestration (CCS) technology is not yet feasible on a large scale. Storage on a large scale is difficult because holding carbon under ground is only possible in the relatively few areas where the earth is not porous. Most coal plants are not located above appropriate geological formations, and transport of carbon dioxide is expensive. Carbon transport and storage also presents legal ramifications. If large amounts of carbon were to escape, the effects could be harmful or lethal to those in the vicinity. We saw an example of what can happen in such a scenario in the 1986 <a href="http://www.time.com/time/magazine/article/0,9171,962228-1,00.html&quot; target="_blank">Lake Nios disaster</a>, where the lake released a concentrated bubble of carbon dioxide and killed approximately 1,700 people.</p>

<p>Additionally, the equipment that captures and stores carbon consumes large amounts of energy, requiring the generation of yet additional carbon. Keith Johnson of the <em><a href="http://blogs.wsj.com/environmentalcapital/2009/06/08/peak-coal-what-do-…; target="_blank">Wall Street Journal</a></em> reports:</p>

<p>A <a href="http://belfercenter.ksg.harvard.edu/publication/19042/making_carbon_cap…; target="_blank">new book </a>by Harvard University's Belfer Center estimates that clean coal plants use 30% more energy than traditional plants - that is, clean coal plants require more coal to produce the same amount of energy as dirty coal plants.</p>

<p>The <em><a href="http://www.economist.com/displaystory.cfm?STORY_ID=13226661&quot; target="_blank">Economist</a></em> further explains the expenses associated with CCS:</p>

<p>The problem with CCS is the cost. The chemical steps in the capture consume energy, as do the compression and transport of the carbon dioxide. That will use up a quarter or more of the output of a power station fitted with CCS, according to most estimates. So plants with CCS will need to be at least a third bigger than normal ones to generate the same net amount of power, and will also consume at least a third more fuel. In addition, there is the extra expense of building the capture plant and the injection pipelines. If the storage site is far from the power plant, yet more energy will be needed to move the carbon dioxide.</p>

<p>Now consider the expense of the initial construction of a CCS coal plant. The FutureGen project is a joint project between the public and private sector to build the first coal-powered, near zero-emissions power plant. The estimated cost of development for the 275 megawatt plant is $1.5 billion. A somewhat smaller <a href="http://www.businessweek.com/magazine/content/08_27/b4091046392398_page_…; target="_blank">150 megawatt wind farm costs about $225 million</a>, meaning wind farms are approximately $1 billion less expensive to build (at least on that scale).</p>

<p>Even if safe, energy-efficient, inexpensive carbon capture and sequestration technology is developed, coal reserves are not unlimited. The government estimates that the U.S. has enough coal in the ground to last 240 years. However, this estimate is misleading. As recently noted in the <em><a href="http://online.wsj.com/article/SB124414770220386457.html&quot; target="_blank">Wall Street Journal</a></em>, last year's U.S. Geological Survey found that only 6% of the coal in the nation's largest and most productive coalfield can be mined profitably. California Institute of Technology professor David Rutledge estimates that coal reserves will last only 120 years, or less than two human life spans.</p>

<h4>The tipping point</h4>

<p>Considering the money available for companies who choose to "go green," the expense of adhering to the increased regulations on the coal industry, and the fact that the profitable coal reserves will eventually run out, it makes sense for policymakers and energy industry executives to begin exploring how they might transition to renewable energy. At present, coal companies aren't clamoring for a way out of the coal business, but it seems evident that time is running out on our coal-fired infrastructure. The question isn't whether or not there's a tipping point, it's how quickly we'll reach it. All signs suggest that moment will arrive sooner rather than later.</p>

<p>If Congress wants to encourage companies involved in our electricity generation cycle to get serious about green technologies, a revision of the tax code allowing wind, hydroelectric, solar and other renewable technologies to be considered "like-kind" with traditional fossil technologies might potentially show fossil companies a path to long-term viability.</p>

<p><strong>The Situation</strong></p>

<p>Blue Jay Energy (BJE) focuses on the exploration, development and production of natural gas and crude oil in several regions of the United States. The company currently has proved reserves in excess of one billion cubic feet of gas equivalent and a reserve-to-production ratio of over 10 years.</p>

<p><strong>The Problem</strong></p>

<p>As is common with energy exploration businesses, Blue Jay’s holdings include some underperforming fields. It recently decided to divest an oil and gas leasehold with tangible field machinery and equipment so that it could reinvest in properties it expected would generate greater yields. The property it intended to dispose of was comprised of 80% real property and 20% tangible well equipment. It quickly found a buyer, but the proposed $12.9 million sale price for their 85% operating interest would result in a tax liability of roughly $4 million.</p>

<p><strong>The Solution</strong></p>

<p>Blue Jay has conducted 1031 real property Exchanges in the past, but has done so with Qualified Intermediaries that rely on inefficient paper-based processes. As a result of this added administrative burden company leadership has never fully integrated Like- Kind Exchanges (LKEs) into their strategic planning, operations and asset recovery strategy.</p>

<p>BJE was referred to Accruit by its bank. Accruit established a qualified escrow account under the Trust company at the bank to assure maximum security of funds. Accruit then helped the firm facilitate the sale and purchase of the new lease and equipment as an LKE.</p>

<p><strong>The Results</strong></p>

<p>The exchange was conducted successfully, allowing the company to defer $4 million in tax liability – money that it then invested in more promising properties and new oil and gas tubing and casing. In addition, Accruit’s patented process and one-to-one client services model created a degree of efficiency that Blue Jay had never imagined possible. Blue Jay’s senior leadership and finance team were enthusiastic about both the monetary benefit and the ease of use associated with the Accruit process. Other QIs they had worked with only specialized in real property and failed to account for the differences between real and tangible assets. Blue Jay is now considering implementation of a full-scale Accruit 1031 program.</p>