How safe are those 1031 Exchange Funds?

By
Services for Real Estate Pros with Malbur Exchange Group & Assoc.

I was just thinking about a St. Paul, Minnesota Qualified Intermediary (QI) that commingled it's exchange funds, then filed for bankruptcy.  It turns out that the QI was day-trading with the client's funds. During the bankruptcy proceedings the court appointed trustee treated the pooled exchange funds as a bankruptcy asset.  This bankruptcy asset was then available to all creditors in satisfaction of debts owed! 

A separate account for each exchange client is sound protection against attachment by the courts. Be sure that the QI separates them at the bank level and have them prove it.  Ask for online (view only) access, through the bank's website, not the QI's for independent verification!

 Again whether it's you or your client doing the exchange, due diligence is important. 

Comments (6)

a b
c - Milford, PA
interesting. I didn't know that was possible.
May 16, 2007 04:00 AM
Ross Willingham
Tomson Real Estate - Stillwater, OK
Realtor Associate
Excellent point Steve.  Those issues are rare but they DO happen.  Better safe than sorry!
May 16, 2007 04:07 AM
Steve Chacon
Malbur Exchange Group & Assoc. - Denver, CO
Thanks for the comments guys.  You are right Ross, the majority of QI's are operating with high integrity.  However, the majority also pool those exchange accounts.  However, the word is getting out on the dangers of pooling accounts and industry practices are changing for the better!
May 16, 2007 04:14 AM
Bill Exeter
Exeter 1031 Exchange Services, LLC - San Diego, CA
1031 Tax-Deferred Exchange Expert

Hi Steve,

I'm sorry to disagree with you, but opening separate bank accounts actually increases the risk that an internal error (human error) might happen or someone will carefully embezzle funds out of one specific bank account that may take quite sometime to catch. 

I've been in the 1031 exchange Qualified Intermediaries world for over 23 years now and I've seen it happen over and over.  I also started out in bank before that and have a few stories that I could tell you about. 

It might work fine for smaller 1031 exchange Qualified Intermediaries ("QI's") and gives them a great "sales pitch", but for those of us that administer 1,000's of 1031 exchange accounts each and every year opening separate bank accounts actually increases the risks that someone might disappear with the funds or more likely just goof because of the number of accounts. 

The actual point to watch out for is those QI's that commingle or pool the client 1031 exchange funds with their corporate funds.  This is when you will have the problems with a bankruptcy filing that you have mentioned. 

We have implemented a sophisticated trust accounting system normally used by banks and trust companies to account and track our 1031 exchange funds positions.  It is an expensive system, but well worth the dollars spent.  We have a separate operations department that is responsible for reconciling and balancing our investment funds position down to the penny each and every day. 

There are many ways of designing and implementing sophisticated internal controls, accounting procedures, segregated responsibilities and departments, and trust accounting systems that can protect a client better than opening separate bank accounts.

Mar 02, 2008 01:04 PM
Steve Chacon
Malbur Exchange Group & Assoc. - Denver, CO

William,

Thanks for taking the time to read my post and make a "sales pitch" of your own.  While the complexity and size of a particular accounting system can be helpful, there is often a point of "diminishing returns" where it actually begins to conceal mistakes and fraudulent activity.  In fact, I have a few stories of my own that I could tell you regarding overly large, complex, or expensive reporting structures and the problems that invariably arise from them.

MEGA 1031 has conducted a careful review of internal controls used by both large and small QI's and, in my opinion, has addressed the issues of commingling and pooling in the safest and most effective way.  In reality, a properly designed system, like ours, offers maximum protection from individual mistakes and fraudulent activity.  In addition, it is naturally transparent to clients, regulatory oversight organizations, courts, and the Internal Revenue Service.  Taking it even further, our internal control system is subject to ongoing monitoring both from within the company and from outside consultants.  

The design of any internal control system requires careful consideration of authorization, record keeping and custody factors.  MEGA 1031 engages the client’s participation in the authorization and monitoring process, without triggering constructive or actual receipt issues harmful to the exchange.  MEGA 1031 also carefully segregates duties related to all three factors within the company ensuring a proper system of “checks and balances”.  Part of the design includes preventing wires into and out of separate client accounts. This, in combination with daily “to the penny” reconciliations, creates a very reliable and very efficient system that is closed and without leaks.  Clients may even go directly to the bank’s website (not ours) for independent “third party” verification and monitoring of their separate accounts.  Any movement of funds is immediately known to our officers, our trust management team, our bank and the client.

Proper controls, a closed system with third party verification / notification 24 hours a day, 7 days a week—it just doesn’t get much safer than that.

In short, the implication that our system somehow exposes clients to more risk could not be more wrong.

 

 

 

 

Mar 03, 2008 04:48 AM
Fred Griffin Florida Real Estate
Fred Griffin Real Estate - Tallahassee, FL
Licensed Florida Real Estate Broker

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Sep 15, 2017 06:22 PM