BROKER RISK MANAGEMENT
WEEKLY PRACTICE TIP
Choosing an Exchange Accommodator
Q: I have heard recently of some 1031 Exchange Accommodators, also known as “exchange facilitators,” going out of business. What are the risks, and how can a client who is going to do an exchange protect themselves?
A: Surprisingly, exchange facilitators are not regulated by any government agency. Literally, until now, anyone can hang out a shingle and claim to be an exchange facilitator.
Further, there have been no regulations on how the exchange funds held by an exchange facilitator are to be handled or invested. Some facilitators have inter-mingled these funds, rather than placing them into separate accounts. Some facilitators also invested these funds in high risk investment instruments.
Because of the difficulties in the investment markets, a number of exchange facilitators have either filed for bankruptcy or gone out of business:
1. LandAmerica Exchange Services filed for bankruptcy in November, 2008;
2. A company called Real Estate Exchange Services recently advised its clients that it is unable to fund client transactions or redemptions;
3. National 1031 Corp. in
4. Summit Accommodators, Inc. closed its doors mid-December, 2008.
These are recent failures, but there have been several other exchange facilitator failures in the past. For example, several years ago an exchange facilitator in Santa Barbara sold to an out-of-state firm which then folded, losing millions of dollars of client exchange funds.
NEW LAW: A law effective
This law requires a person engaging in the business as an exchange facilitator for a 1031 exchange to:
A. Comply with certain bonding and insurance requirements (see below for details);
B. Notify existing exchange clients whose relinquished or replacement property is located in
C. Act as a custodian for all exchange funds, and to invest those funds in investments that meet prudent investor standards (as set forth in the Uniform Prudent Investor Act at Probate Code 16045, et seq).
Finance Code Section 51003 provides:
(a) A person who engages in business as an exchange facilitator shall at all times comply with one or more of the following:
(1) Maintain a fidelity bond or bonds in an amount not less than one million dollars ($1,000,000), executed by an insurer authorized to do business in this state.
(2) Deposit an amount of cash or securities or irrevocable letters of credit in an amount not less than one million dollars ($1,000,000) in an interest-bearing deposit account or a money market account with the financial institution of the person’s choice. Interest on that amount shall accrue to the exchange facilitator.
(3) Deposit all exchange funds in a qualified escrow account or qualified trust, as those terms are defined under Treasury Regulation 1.1031(k)-1(g)(3), with a financial institution and provide that any withdrawals from that escrow account or trust require that person’s and the client’s written authorization.
(b) A person who engages in business as an exchange facilitator may maintain a bond or bonds or deposit an amount of cash or securities or irrevocable letters of credit in excess of the minimum required amounts.
(c) If the person engaging in business as an exchange facilitator is listed as a named insured on one or more fidelity bonds that total at least one million dollars ($1,000,000), the requirements of this section shall be deemed satisfied.
PRACTICE TIPS:
1. When representing a client who is choosing an exchange facilitator to handle their funds pending the closing of the up-leg property, do not recommend an exchange facilitator to your client.
2. Advise the client that THEY should make the decision as to which exchange facilitator to use, and to exercise due diligence in making the selection.
3. Advise the client to request:
A. Evidence of compliance with the bonding and insurance requirements;
B. A statement of the facilitator’s investment policy and compliance with the “prudent investor standard;” and
C. Individual investment accounts for each client.
4. With respect to any exchange funds currently with an exchange facilitator, advise clients to take the above steps and, if not satisfied, to consult with their tax advisor prior to taking any steps.
5. When representing a buyer or seller engaging in a 1031 exchange, always use the proper contract addendum:
A. Buyers exchanging into a property: Use the “Buyer Intent to Exchange Supplement.” (WinForms form BES)
B. Sellers who will be exchanging into another property: Use the “Seller Intent to Exchange Supplement.” (WinForms form SES)
See Weekly Practice Tip “Handling 1031 Exchanges
6. When representing sellers who will be engaging in a delayed 1031 exchange, have the sellers sign the attached Advisory after having gone over it with them.
This Weekly Practice Tip is attorney-client privileged and for the exclusive use of clients of Broker Risk Management and their agents. It may not be reproduced or distributed without the express written consent of Broker Risk Management. The advice and recommendations contained herein are not necessarily indicative of standards of care in the industry, but rather are intended to suggest good risk management practices.
© Copyright Broker Risk Management 2008 Revised:
(INSERT BROKER NAME HERE)
1031 EXCHANGE ADVISORY FOR SELLERS
Because a number of 1031 Exchange Facilitators have failed recently, those sellers who are contemplating engaging in a delayed 1031 exchange must take care in selecting the Exchange Facilitator to hold their sale proceeds pending the completion of the exchange. For this reason, we recommend that you do the following:
1. Interview several Exchange Facilitators, and ask for and check out references, before selecting one to handle your exchange.
2. Determine that the Exchange Facilitator has met the minimum
(a) A person who engages in business as an exchange facilitator shall at all times comply with one or more of the following:
(1) Maintain a fidelity bond or bonds in an amount not less than one million dollars ($1,000,000), executed by an insurer authorized to do business in this state.
(2) Deposit an amount of cash or securities or irrevocable letters of credit in an amount not less than one million dollars ($1,000,000) in an interest-bearing deposit account or a money market account with the financial institution of the person’s choice. Interest on that amount shall accrue to the exchange facilitator.
(3) Deposit all exchange funds in a qualified escrow account or qualified trust, as those terms are defined under Treasury Regulation 1.1031(k)-1(g)(3), with a financial institution and provide that any withdrawals from that escrow account or trust require that person’s and the client’s written authorization.
(b) A person who engages in business as an exchange facilitator may maintain a bond or bonds or deposit an amount of cash or securities or irrevocable letters of credit in excess of the minimum required amounts.
(c) If the person engaging in business as an exchange facilitator is listed as a named insured on one or more fidelity bonds that total at least one million dollars ($1,000,000), the requirements of this section shall be deemed satisfied.
3. Inquire whether your exchange proceeds will be kept in: (a) secure, low-risk accounts; and (b) separately identifiable accounts and not commingled with other clients’ exchange funds.
4. Discuss all of the above with your tax advisor prior to proceeding.
Because Exchange Facilitators are not regulated by any governmental agency, there can be no guarantee, even with the above due diligence, that any one Exchange Facilitator may not fail. So, we recommend that you choose your Exchange Facilitator exercising utmost care and diligence.
Seller: __________________________________ Date: ______________, 20__
Seller: __________________________________ Date: ______________, 20__