Your Trusted Section 1031 Advisor

Headlines Today…

The 1031 Tax Group, LLC, a group of qualified intermediary companies purchased recently by Edward H. Okun, filed Chapter 11 reorganization in the U.S. Bankruptcy Court on May 14th, 2007.  While Okun’s lawyer said that the company is filing bankruptcy to protect its clients.  $157 million in clients assets owed $151 million to 300 people are missing.

Southwest Exchange Inc. (based in Nevada) and Qualified Exchange Services, Inc (based in California) were purchased by Don McGhan of Capital Reef Management to gain control of the businesses. McGhan diverted $83 million dollars in client funds in February, 2007 for other business investments.

Current IRS Announcements and Cases:

• The IRS now recognizes television network affiliation agreements as like-kind property. FAA 20072101F
• Exchange of one Vacation Home for another did not qualify for Section 1031 Treatments, Moore v. Comm T.C. Memo 2007-134 (5/30/07)
• In a parking transaction, relinquishing property through qualified intermediary before expiration of 45 days from date replacement property is parked satisfies identification requirement. PLR 200718028
• Section 1031(f)will not apply to trigger gain recognition in related party reverse like-kind exchange using qualified intermediary where related party expects to dispose of relinquished property within two years of acquisition. PLR 200712013

.BNA Tax Management

Stephen L. Robison, J.D., LL.M.
Taxation and Business

Avoid Bankruptcy with your Section 1031 Exchange.

Recent headlines (left) broadcast the recent loss of many millions of dollars of real estate investor’s savings because 2 rogue Qualified Intermediaries diverted funds for business reasons. How did this happen? In June 19, 2007 edition of the Financial Times, an article on the changes in financial capitalism, “ The new capitalism” www.ft.com/wolfforum the author describes an entirely new form of capitalism, where financial entities use financial assets  of others to make money for themselves. No longer content with simply providing services, new global financial capitalists are using the liquid financial assets of others to fuel their growth. What lessons can we learn from this calamity?  

Ten Points to consider in Selecting a Qualified Intermediary for your client.

1. A Qualified Intermediary should have a Fiduciary Insurance Bond in an amount equal to the client funds on deposit and should be able to provide this bond to each client at any time; Fiduciary bonds cover losses resulting from dishonest acts, ie, defalcation, embezzlement, conversion, theft, fraud and the like, by employees, officers, owners and partners.
2. A Qualified Intermediary should not commingle operating funds with client exchange funds and each exchange should have a unique file identification, [the companies listed did not].
3. A Qualified intermediary should have their client fund accounts reviewed by an independent certified public accountant.
4. A Qualified Intermediary should have a written agreement with each exchange client.
5. Inquire as to whether the management of the Qualified Intermediary has changed recently. [the 2 major companies had just been acquired by outsiders for the express purposes of gaining access to the funds].
6. Section 1031 exchanges should be the primary business of your Qualified Intermediary, rather than a side business for the parent company designed to accumulate liquid assets of clients who are exchanging property.  
7. A Qualified intermediary should be able to certify to each client that their 1031 Exchange was properly and correctly handled and provide Errors and Omission Insurance for each client. An example of errors covered under an E&O insurance includes missed deadlines, replacement values less than the relinquished property and incorrect allocation of expenses. What is not covered is dishonest acts, fraud and market value guarantees, or services performed in a capacity other than as QI. Key issues to look for are prior act limits and who is covered under the policy.
8. A Qualified Intermediary should provide objective proof of their 1031 exchange Expertise or credentials; and
9. A Qualified Intermediary should not be chosen solely on the basis of a low fee or no fee at all. An exchange intermediary that charges little or no fee has another agenda that probably is not in your best interest.
10. Advisors are now accountable to the IRS, under civil and criminal tax penalties, for the proper tax reporting of an Exchange.  You want an Intermediary that is an expert in tax law for Section 1031Exchanges and will protect the client as well as their advisors in the case where the Section 1031 Exchange is challenged.