Your Trusted
Section 1031 Advisor Newsletter

WILL YOUR SECTION 1031 EXCHANGE FAIL WITH A BANK AS THE QUALIFIED INTERMEDIARY?

Inside this newsletter issue:

• Are Banks (actually or legally) Qualified Intermediaries (QIs)?
• Requirements for Banks to Hold Proceeds from Sale of Relinquished Property
• What is the Downside of Banks not meeting these Requirements?
• What are Other Situations where a Bank may NOT be used as a QI?
• How can you know if a Bank does not understand the rules under Section 1031, or disregards the rules?

Are Banks (actually or legally) Qualified Intermediaries (QIs)?
Many Banks fill the role of “custodian of the funds” during a Section 1031 Exchange, especially Banks where the taxpayer has a preexisting depository relationship. Typically, the taxpayer’s attorney handles the documentation of the exchange, in his or her traditional role as the advisor. Sometimes, these Banks will call themselves Qualified Intermediaries.  While the terms “custodian of the funds” and “Qualified Intermediary (QI)” are commonly viewed as synonymous or interchangeable, most Banks holding the funds are not (actually or legally) QIs.

The QI is permitted, under the Treasury Regulations, to provide additional services in the 1031 Exchange, such as a tax opinion, tax advice or tax reporting. The taxpayer’s attorney, CPA or other existing advisors (e.g., bank advisors) are disqualified parties, and they are prohibited from serving in this capacity.

Requirements for Banks to Hold Proceeds from Sale of Relinquished Property
Based on Section 1031, there are specific requirements in order for any Bank (as custodian of the funds) to hold the proceeds from a sale of relinquished property.  These requirements include:

• The funds must be held in a qualified escrow account or in a qualified trust. 1.1031(k)-1(g)(3)(i).
• The escrow holder or trustee cannot be a disqualified person.
• The taxpayer's rights to receive, pledge, borrow, or otherwise obtain the benefits of the cash or cash equivalent held in the escrow account or by the trustee must be limited to circumstances specified in Treasury Regulation 1.1031(k)-1(g)(6).
• The qualified escrow agreement or trust agreement must incorporate the integrated terms of the exchange, including binding the non exchanging parties, providing the necessary series or interdependent transfers, directing the flow of monies, identification and other Section 1031 requirements. (Allen vs. Comm., Hillyer vs. Comm. Klein vs. Comm.)

The Bank cannot, in actual practice, disregard the above requirements.

What is the Downside of Banks not meeting these Requirements?
While these requirements seem straightforward enough, many Banks typically just set up a Bank account and put the funds in without meeting any of the above requirements.  This will cause the 1031 exchange to automatically fail, regardless of whether replacement property is acquired. Size of the bank is no protection. I have dealt with National Banks that violate the rules routinely and with impunity. Their entire focus is on gaining deposits, not concerning themselves with the IRS rules related to Section 1031 Exchanges.

I have witnessed numerous situations in which Banks remove or transfer funds out of the exchange account in contravention of the 1031 exchange rule. They were done either at the request of the taxpayer or for other banking needs, such as payment to the Bank under loan agreements. While the Bank officials believe that they are acting in the taxpayer's best interest, they are causing the Section 1031 exchange to automatically fail.

What are Other Situations where a Bank may NOT be used as a QI?
Other types of Exchanges where a Bank, under the qualified escrow account or in a qualified trust, may not be used as a QI include:

In 2008, this is all the more salient. Recently, the IRS announced that they will begin to audit 1031 Exchanges in earnest, due to the results of their review of an estimated 338,000 exchanges from the 2004 tax year. In addition, new IRS penalty provisions for advisors will assess civil tax penalties where the Exchange was reported incorrectly, regardless of the advisor’s actual knowledge.

How can you know if a Bank does not understand the rules under Section 1031, or disregards the rules?
Ask the Bank, in advance, if they will release funds to the client if the client requests the funds be released. If the Bank replies “Yes”, then they are not qualified to serve as custodian of the funds or as QI.

Or, talk to the professionals at Strategic Property Exchanges, LLC. We understand the complex rules of Section 1031 exchanges, and we can help simplify this information for you and your clients. Stephen L. Robison, Esq., is a Qualified Intermediary and is a full time practicing tax attorney, who is Board Certified as a Federal Tax Specialist. Mr. Robison, and our team of professionals, will work with you and your clients. They will creatively and strategically assist you and your client with the sale or purchase of a business, in order to maximize the tax deferral opportunities.

UPCOMING SEMINARS

February 12, 2008
Indianapolis, IN

Section 1031 Exchanges
Presented to Indianapolis REIA
_______________

NBI SEMINARS

February 19, 2008
Indianapolis, IN

Advanced Section 1031 Exchanges
_______________

February 21, 2008
Lexington, KY

Advanced Section 1031 Exchanges
_______________

March 19, 2008
Cleveland, OH

Advanced Section 1031 Exchanges


All NBI seminars
will be held
8:30 A.M. - 4:40 P.M.

For more information
visit the NBI web site at www.nbi-sems.com