How To Avoid Embezzlement In A 1031 Exchange Deal: William Exeter’s Due Diligence Advice

I am neither an expert or a current tax/investor looking to complete a 1031 exchange and avoid the nasty capital gains taxes in the process. I am not an attorney, real estate broker, or qualified intermediary professional giving advice or performing 1031 exchanges. I am simply a conduit for information that hopefully will enlighten some people, inform others, and make aware all investors to the possibility of embezzlement of their life savings in a 1031 exchange deal gone bad.

My series on the 1031 Tax Group (Ed Okun) and Southwest Exchange (McGhan) have outlined the serious problems the 1031 exchange industry is suffering currently. In reporting on my findings, many readers have commented online and off on their substantial losses; some of these people have lost their life savings and retirement nest eggs to embezzlement.

Therefore I have attempted to provide a source of information about alternative investment tools to the 1031 exchanges, ongoing news about legislation of the industry, and information from industry professionals whose reputations are at stake due to the actions of the few illegitimate men within this niche.

The following is advice for consumers when performing their due diligence on a prospective 1031 exchange company. The author of this advice is William Exeter President and CEO of Diversified Exchange Corporation. His paper is titled “How to Evaluate and Select Your Qualified Intermediary (Accommodator).”

According to Exeter there are 3 major risks when considering a 1031 exchange:

1. Embezzlement or theft of the 1031 exchange funds
2. Errors or omissions in the administration of the 1031 exchange
3. Voluntary or involuntary bankruptcy filed by the Qualified Intermediary

One tip for avoiding possible embezzlement or theft, according to Exeter, is to verify that the QI maintains Fidelity bond coverage. The idea is to verify that the bond coverage is “in full force and effect and to determine the policy limits.” The consumer should request a copy of the QI’s insurance binder as well as the contact information of the insurance company/agent for the QI. When speaking to the insurance company ask the following questions: “Is the Fidelity bond coverage “per occurrence” or merely in “aggregate”?

In aggregate means that their is a policy limit based on an annual amount and limited to that dollar amount regardless of the number of thefts during the year. The “per occurrence ” means that each theft is covered up to the policy limit. According to Exeter, there can be a big difference in coverage between the two.

In regards to Errors and Omissions insurance, the consumer should take the same steps as outlined for their due diligence on a QI’s Fidelity bond insurance. Ask for a copy of the insurance binder and the QI’s insurance company contact information. Call and verify that the Errors and Omissions insurance is in fact “in force” and verify the policy limits.

“Bankruptcy is a rare event within the 1031 exchange industry” according to Exeter. Unfortunately it is possible and should be considered. The following information may help consumers perform their due diligence. This information may help consumers avoid having  their 1031 exchange funds lost in a bankruptcy case.

Consumers must ensure that their funds will not be held under their QI’s corporate name. If this is the case, then the consumer’s funds will be considered part of the bankrupt QI’s estate. This estate is then used to pay off any creditors owed monies by the QI.

The Department of the Treasury provides for Qualified Trust accounts or Qualified Escrow accounts. These accounts are considered “fiduciary funds and not subject to the bankruptcy estate or creditor claims.”

These tips and suggestions by Mr. Exeter are just a beginning taste of what each consumer must consider when performing their investigation on a Qualified Intermediary. Please remember to consult your tax professional or legal expert when performing this investigation process.