1031 Exchange Due Diligence: Is Bigger Better When Choosing Your Qualified Intermediary?

Although the majority of small, medium, and large Qualified Intermediary companies do a admirable job, the recent spate of 1031 Exchange company rip offs has consumers on edge and weary of the 1031 process as a whole. The only safeguard consumers have against possible wrongdoing is to perform thorough due diligence on the exchange company of their choice.

The following is not a commercial for First American Exchange; instead it is one company’s checklist for consumers in the market for exchange services. Of the many points of interest to consumers, the following are the most important:

*First Exchange is owned by the First American Title Co. and is the largest provider of business information in the country; the company dates back to 1889.

*First Exchange is a subsidiary of First American Title Co. and First American Title Co. provides a “closing protection letter ensuring transactions are protected from any loss of funds as the result of negligence, fraud, or dishonesty on the part of any First American employee.

*First Exchange is governed by financial reporting and disclosure requirements of the Sarbanes-Oxley Act 2002.

*First Exchange maintains a “multi million dollar fidelity bond and professional liability insurance from an independent underwriter.”

*Company revenues were 8.1 billion in 2005 with assets of 7.5 billion.

As with anything I post, I suggest each consumer do their own due diligence on more than one company or issue. I do not stand behind nor endorse any of the above claims; rather I report what has been made available to me.

Hopefully this information provides the motivation for any consumer to perform their own due diligence investigation when in the market for services.

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11 thoughts on “1031 Exchange Due Diligence: Is Bigger Better When Choosing Your Qualified Intermediary?

  1. Dean

    With the recent spate of QI failures there is no doubt that real property investors have become quite concerned about how to choose a QI. I have been in the Qualified Intermediary business for nearly 30 years and I can confirm that there are some very real indicators of the security of any QI.

    First: Look for completely segregated accounts. I am also an attorney and my law firm is required to segregate all trust funds held for a client. While QI funds are not trust funds in the true sense of the word, there is no reason they should be treated any less strictly. Funds are co-mingled by QI for their benefit and not the customer. More on this below

    Second: Don’t be confused by Fidelity Bonds or Insurance. What a customer needs to require is some sort of joint signatory control over the segregated account. Insurance or bonds may (or may not) provide some source of recovery if funds are lost, but an exchanger needs the funds to be there when they are to complete their exchange and the ONLY way to assure that is to have some control over the funds during t he exchange period. Size and financial strength of a QI may seem like all that is needed but without this security, there is no assurance your funds will be there when you need them

    Third: Insist that you receive ALL interest earned on your funds. The reason QIs co-mingle funds and the reason QIs lose funds is that they usually receive some or all of the interest earned on those funds. Hence there is an incentive for the QI to take risks with the funds to increase their (not the customer’s) return. Not only does this arrangement hide the true cost of the exchange, it is essentially stealing the return the exchanger is entitled to receive. Less than 4% of the QI nationally pay all the interest earned to the exchanger. Look for these companies Compare the actual cost (including lost interest) when comparing fees the QI will be paid. Often the “cheapest” QI may keep the most interest and become the most expensive option. TJ Starker received “interest” and there has never been any reason all exchangers should not receive this interest.

    Fourth: Often smaller companies (who do provide the necessary security) can provide greater flexibility and assistance in your exchange. Larger companies can only offer “cookie cutter” services and I can assure you every exchange is unique and will present issues that should be discussed and reviewed. When you want personalized professional service, you will find it in the very experienced smaller QI companies.

    Fifth: Look for experience and a long term track record. Ask other professionals about which QI they would use. Attorneys CPAs and experienced commercial real estate brokers will often have experience with a variety of QI and may provide some insight into who is best in your area. Remember that the QI need no be local as long as they meet your standards.

    These concepts are not rocket science, but it is amazing how often exchangers don’t do even the most basic “homework” before picking the QI who will hold their exchange funds.

  2. Rob,

    Thank you for the information rich “education” on this subject. It amazes me how many people have contacted me withOUT mentioning the due diligence process.

    I would like to challenge any and all large company representatives to either support or refute what Rob has outlined in his comment. Rob is with a smaller firm so I am guessing a large company like First American would be interested in giving a “rich” detailed rebuttal?

    Please keep in touch as more is in the offing according to a few of my sources. I look forward to more discussion on this subject. Thanks!

  3. As one of the 350 victims of Mr. Edward H. Okun and the bankruptcy of his 1031 Tax Group, I’ve been reading articles on 1031’s posted here and elsewhere closely. For the record, we did our “due diligence” on Security 1031 Services, LLC (one of the “roll up” 1031’s Mr. Okun had quietly acquired in the two years leading up to this bankruptcy. I say “quietly” because his acquisition of the long term, well known, reputable 1031’s across the country was not at all evident to those who regularly used their services (since he kept all their management teams, including the former owners, in place), nor was his eventual insistence that they transfer their exchange funds (actually held by them in separate accounts identified by each exchanger) into a comingled account from which he then liberally “borrowed” for his own purposes. Security 1031 Services was recommended to me by my real estate attorney as a reputable company with which he had done multiple transactions over the years with no problems (several in the months just prior to the bankruptcy). Security 1031 Services was a member, apparently in good standing, of the FEA (I visited their website as well). I’m not at all sure what that membership or FEA “certification” actually implies, since their only response seems to have been to quickly delete the names of the bankrupt affiliates from their website and otherwise disavow them. It regularly taught 1031 seminars to real estate groups and law schools (which I found on those websites not on Security 1031 Services’ website). It had a fidelity bond for $10 million (the relevance of which is questionable since I had no way of knowing the size of the outstanding exchanges held by Security 1031 Services that bond was intended to cover, but it also seems Mr. Okun must be charged with fraud or other criminal activity in order for them pay off, and in a bankruptcy case, they pay the “estate” whose resources may get distributed first to everyone BUT those of us whose exchange funds constitute the 1031 Tax Group’s only apparent assets. (In truth the 1031 Tax Group’s only “assets” appear to be a pile of worthless unsecured IOU’s for $135 million.) As to advice posted here that the exchangers each insist that their signatures be required to make any transfers to ensure “control” of the exchange funds, my attorney and a close reading of the IRS 1031 regulations would that this would nullify the exchange since the IRS specifically requires the exchanger to surrender all such “control.” When the IRS issued its 1031 regulations requiring that taxpayers surrender control of their sales proceeds to a “Qualified Intermediary,” an industry those regulations created, they should have prescribed as well the oversight responsibility and regulations governing that industry. Their continuing failure to do so has left at least 350 of us reeling and probably put a stake in the heart of the 1031 exchange industry since, despite protests from various 1031 Qualified Intermediaries on this website and elsewhere, there doesn’t appear to be any certain way of guaranteeing the security of those funds.

  4. Elizabeth,

    First let me say I am sorry for your loss and hardship. What Okun and his cronies have done seems to be downright criminal in nature yet it looks as if nothing is going to happen to the man.

    Thank you for the rich detailed email. I believe people who read your account will benefit indirectly. I appreciate it very much. Please keep us updated on any new developments you may find. Thank you again!

    Dean

  5. Pingback: One of the 350 Victims of Ed Okun’s Bankrupt 1031 Exchange Empire Speaks Out:”The Most Compelling Case Yet for Action to Be Taken!” « DeansGuide

  6. Elizabeth,

    I am by no means the right person to speak for the FEA but I would like to defend them. No one ever expected something like this to happen (Ed Okun’s group). We all stick to a strict code of ethics that would never allow this. Your situation was in fact anomolly. You did do everything that you could. Many of the people involved in this did the right things. They found a way to abuse their customers and it was wrong. The old owners fought not to move those funds and were removed from their positions due to them trying to protect you. It was sneaky and wrong. The FEA has now gone to great measures to make sure that never happens again. Many states have begun to institute regulations on QI’s as well to ensure that you are safe. It was very unfortunate that anyone has to go through this in order for it not to happen again but rest assured – it wont.
    There are many QI representatives fighting to have some tax alleviation for all of you by the way of some kind of extension or the right to fight. Right now all the QI’s are being labelled because of what happened, they are pirates, mob divisions and thieves which is simply as unfair to them as it was to have this happen to you. I wish everyone the best in this terrible situation. Down with anyone who breaks the trust of their loyal customers!

  7. Melanie,

    The FEA is not responsible for the actions of the rogue few that tarnish the good name of the majority of QI’s in this country. Yet I can’t help but take issue with the thought that anyone needs to defend the FEA.

    The FEA has in it’s hands one of the greatest opportunities any business could have in any niche. They have the opportunity to grassroots move politicians into mandating laws and regulations for the industry that they represent. The FEA has not taken on this function nor do they seem ready or set to make a nationwide movement of the sort.

    Do you have some information we do not have at this time regarding new regulations or laws being championed by the FEA? Is there a local, state, and national campaign by the FEA to law makers in this country we have not yet heard about at this time?

    How can you make the statement: “It was very unfortunate that anyone has to go through this in order for it not to happen again but rest assured-it won’t” What information do you have that tells us that no other unregulated, unlawful QI will NEVER rip off innocent investors ever again?

    Dean

  8. Remember it is IRS requirement that All Cash Equity be “Constructive Receipt” putting investor’s monies in an account with the investors’ name on it goes against Constructive Receipt. Co mingling funds have nothing to do with less or more added securities. Those who lost went with a company that mishandeled funds based on the way they do business and those companies did not fall under the “Title” owned companies which certainly gives a strong amount of added security.

  9. Dean, would appreciate your help getting the word out to the 350 victims of Okun’s bankrupted 1031’s that the DEADLINE for filing “proofs of claim” against the bankrupted 1031’s is NEXT WED, August 24,2007, 5:00 PM EST, by which time the form (and supporting documentation) must be received by the Bankruptcy Court in NY. The information re how and where to send the document is on the Committee website http://www.committeeinfo.com/1031/pdf/99.pdf.
    I’m concerned that not every one of the claimants will have gotten the word (which should have arrived in a hard copy letter to their residence) because the attorneys for the Debtors had my address totally wrong (different stree/city/state — not one I’ve ever lived at) and I wouldn’t have known it if someone else hadn’t mentioned they’d rec’d mail I hadn’t. If they garbled my contact information that badly, they could easily have garbled others’ and how would anyone know? So, your help headlining this deadline for Okun’s victims who may not be aware would be very helpful.
    Thanks,
    Elizabeth H. Callanan

  10. Pingback: DEADLINE WARNING: Is August 24, 2007 Really the Last Day To File Claims Against Debtors aka 1031 Tax Group? « DeansGuide

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