Federally Insured Qualified Intermediaries: “1031 Regulation Act of 2007” Is This The Answer To 1031 Tax Group Embezzlement Cases?

In a shocking and eye opening plea from a long time trusted reader, the following comment was left as a request for publication. In August of 2007, California State Congresswoman Zoe Lofgren (somebody I took to task) introduced a bill designed to remove the possibility of embezzlement in a 1031 Exchange transaction like the Ed Okun 1031 Tax Group or Donald McGhan Southwest Exchange cases

Analysis: 1031 Regulation Act of 2007 is an alteration to IRS Tax code dated back to 1986. By requiring federal insurance for every 1031 Exchange, the government then becomes responsible for law enforcement, certification, and approval of QIs going forward.

Fallout: Would the large monolith title insurance companies such as First American take issue with such a law? It would appear that those companies would lose their insurance premiums to government controlled, insured 1031 Exchange insurance; or would the large title insurers be forced to acquired federal insurance riders themselves? Only time will tell–that is if this bill ever sees the light of day!

The following is the comment left on deansguide:

“Dean: Please post this information of a bill introduced in Congress last August. It’s to protect 1031 exchanger’s money through a federally insured program. Though it doesn’t help us current train wreck victims, it will hopefully keep it from happening to others in the future. People need to contact their congressmen in support of the bill.

http://thomas.loc.gov/cgi-bin/query/z?c110:H.R.3420:

H. R. 3420
To amend the Internal Revenue Code of 1986 to require the use of Federally insured intermediaries for nonrecognition treatment on like-kind exchanges involving cash to be used to acquire the replacement property.

IN THE HOUSE OF REPRESENTATIVES

August 3, 2007
Ms. ZOE LOFGREN of California introduced the following bill; which was referred to the Committee on Ways and Means

——————————————————————————–

A BILL
To amend the Internal Revenue Code of 1986 to require the use of Federally insured intermediaries for nonrecognition treatment on like-kind exchanges involving cash to be used to acquire the replacement property.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the `1031 Regulation Act of 2007′.

SEC. 2. FEDERALLY INSURED INTERMEDIARIES REQUIRED FOR LIKE-KIND EXCHANGES INVOLVING CASH TO BE USED TO ACQUIRE REPLACEMENT PROPERTY.

(a) In General- Subsection (a) section 1031 of the Internal Revenue Code of 1986 (relating to exchange of property held for productive use or investment) is amended by adding at the end the following new paragraph:

`(4) REQUIRED USE OF FEDERALLY INSURED INTERMEDIARIES FOR EXCHANGES INVOLVING CASH TO BE USED TO ACQUIRE REPLACEMENT PROPERTY- Paragraph (1) shall not apply to any exchange as part of which cash is received by the taxpayer which is to be used to acquire like-kind property unless such cash is at all times before being so used held as a deposit in–

`(A) any insured depository institution (as defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813)), or

`(B) any insured credit union (as defined in section 101 of the Federal Credit Union Act (12 U.S.C. 1752)).’.

(b) Effective Date- The amendment made by this section shall apply to transfers after the date of the enactment of this Act in taxable years ending after such date.”

Dec 31, 4:01 PM —

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7 thoughts on “Federally Insured Qualified Intermediaries: “1031 Regulation Act of 2007” Is This The Answer To 1031 Tax Group Embezzlement Cases?

  1. Dean

    Do not be misled by this horrible proposed legislation because it helps no one.

    As long as a QI places funds with a federally insured institution, the innocent client would assume this provision is being adhered to.

    However, without some control by the client over withdrawal or movement of those funds, under this new provision, the mere act of removal from the federally insured institution will destroy the exchange unbeknown to the client.

    Therefore even if the funds are not embezzled, movement of them alone will cause the exchange to longer be “tax deferred” even if they are later used to acquire properly identified replacement property.

    Such “window dressing” is useless and will not prevent the kinds of losses Okun and McGahn created.

    I harken back to my “mantra” which is that E & O insurance, fidelity bonds or legislative sanctions such as this will not help.

    The ONLY way to fully protect funds held by a QI is to require dual signatory accounts where the client AND the QI must BOTH sign before any withdrawal or movement of the funds is permitted.

  2. Rob,

    Great to hear from you. I appreciate your thoughts on this subject and any more information you wish to bring forward to help readers.

    If I know my readership, I suspect someone will question your motivation for the position you take in light of the fact that you are a Qualified Intermediary. I also assume that this will hurt QI’s across the board if it comes to pass?

    In any instance, please watch out for any new comments and feel free to answer those folks if they do indeed come up with questions for you.

    Thanks again Rob!

    dean

  3. No Dean

    As written this won’t hurt competent ethical QI’s at all

    Remember that it does not required that the QI itself be a federally insured entity, only that the funds be placed in a federally insured entity like a bank

    In the case or our QI, we only place our funds in federally insured entities so we have always complied with this.

    Okun and McGhan could both have complied with this restriction and then later moved the funds in violation of it.

  4. The question I have is how do you ensure the QI has placed the funds within a federally insured credit union? It seems this would only work if the credit union had the ability to distribute the funds in accordance with a dual signature from both the client and the QI.

    But due to having to avoid the dangerous nature of being in constructive receipt of the funds, the QI has to take a backseat to most of these procedures.

    In addition, this legislation just adds another straw man to an already complicated process.

    If stocks for stocks aren’t seen as deferrable gains, why do we treat real estate differently?

  5. To answer Jimmy’s questions:

    1. I agree this will only work if the customer has some signatory control over any movement of the funds.

    2.The customer can require the bank wire transfer instructions be delivered to escrow and be unalterable before assigning any rights to the QI.

    3.It is quite easy to provide the customer with dual signatory power over the funds without causing constructive receipt.

    4.

  6. I will try to answer Jimmy’s questions:

    1. I agree this concept will only work if the customer has some signatory control over any movement of the funds.

    2. The customer can require the bank wire transfer instructions to a qualifying bank be delivered to escrow and be unalterable by the QI even before assigning any rights to the QI.

    3. It is quite easy to provide the customer with dual signatory power over the funds without causing constructive receipt.

    4. There is no added “straw man” since it only requires that the funds be deposited into a federally insured bank which is really the only place they ever should have been deposited in the first place.

    5. Under this code section, real estate has been specifically treated differently than stocks and bonds (I assume) because the later are far more liquid and negotiable. It has been this way since 1921 when a precursor to §1031 was first enacted into the Internal Revenue Code.

    Let me know if this answers your questions Jimmy

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