1031 Exchange Risks
The 1031 Exchange industry is an unregulated industry. Property owners interested in doing 1031 Exchanges need to educate themselves about the risks involved with 1031 Exchanges.
The biggest risk – losing all your money. There have been many cases of 1031 Exchange companies closing their doors and the principles disappearing with all of the money.
1031 Exchange companies make most of their profit on the float. While property exchange transactions are processing, the monetary funds are being leveraged by the 1031 Exchange company to produce income and profit.
All that money sitting around coupled with some bad decisions has led to ruin for many property owners when the funds vanish.
Dean Guadagni has a great series of posts over on his blog Dean’s Guide on the burgeoning crisis in the 1031 Exchange industry. Start with this one:
June 4th, 2007 at 3:50 pm
John,
Thank you for the recognition. . .
My eight article series on the 1031 Advance of San Jose fiasco can found in the category “1031 Exchange” on my blog site.
June 5th, 2007 at 7:45 pm
John,
Always enjoy your blog about everything going on in the marketplace. Never had a reason to write in until this subject came up. I work for a local 1031 Qualified Intermediary and the news out there is indeed troubling with some people losing their life savings by one bad transaction. It’s also true that a convicted felon could be released from prison and start a QI company the next day; the lack of regulation is at times frightening.
There are a couple things I can advise you and your other readers on to make a safe choice when choosing a 1031 intermediary:
-First and foremost, make sure that your money is ALWAYS being held in a segregated accounts and NEVER pooled accounts. Most good intermediaries already do this, but make sure after you close escrow that you get information on where your funds are being held, the account number, and the total amount of funds.
-QI companies can also set up the accounts as co-signature accounts, requiring both the signature of the QI and the account holder signature to move the funds anywhere. This amounts to a little more work for your clients to sign the card with a bank officer present but is an extra safety step that can be a smart one.
-Make sure that your exchange company has insurance or a Fidelity Bond and that this is active. Many investors take companies at their word, when just asking for a copy could have avoided the problems that happened with Southwest 1031 where the bond had lapsed. The current situation with the 1031 Tax Group is more of a funding issue, and while most people will most likely eventually receive their funds back to them because of their active bond, they will be past the IRS section 1031 timeline and owe tax on their gains, which is precisely what they were trying to avoid in the first place!
-Check for any credit rating company (such as Dun & Bradstreet) that a QI is rated by. If a company shows no outstanding debt, it obviously makes it highly unlikely that company would need to declare bankruptcy in the near future.
-Don’t fall into the trap to think that you are automatically safer using a title insurance company affiliated QI. Aside from the possible conflict of interest, you might end up paying much higher fees and getting less interested returned back to you. If you do your due diligence, you can use one of the MANY safe, independent QI companies out there and get the best deal, best service, and best price.
-Lastly, make sure you always ask how long the company has been in business, how many exchanges they have completed, information about their ownership, and for any references that they have worked with.
I hope this information can be of help, have a great day!
Brian Linhart