The Qualified Intermediary provision of the Section 1031 Like Kind Exchange is the only flaw in an otherwise perfect system.
But it is a fatal flaw.
Whatever you do, do not sign any document turning over your Net Sales Proceeds to a Qualified Intermediary to put into his account unless you have the advice of an Attorney.
This is serious!
When you sell your investment property in a Section 1031 Exchange, you are required to have your Net Sales Proceeds held by an independent third party called a Qualified Intermediary, and the funds can be lost or stolen.
QUALIFIED INTERMEDIARY MIDDLEMAN
Section 1031 of the Internal Revenue Code allows you to sell “property held for productive use in a trade or business or for investment,” called your Relinquished Property, and defer taxes on the Capital Gains, your profit.
This is done by purchasing another property, called the Replacement Property, within 180 days, using the Net Sales Proceeds from the first sale, the sale of the Relinquished Property.
One of the 1031 Exchange Rules, however, requires that an independent third party must take possession of the Net Sales Proceeds from the sale of your Relinquished Property, and hold the funds until the closing on the purchase of the Replacement Property, so that you never have possession of, nor control over, the funds.
The problem here is that the IRS requires you to use someone called a Qualified Intermediary to hold these funds.
QUALIFIED INTERMEDIARY ESCROW ACCOUNT
The Qualified Intermediary is the one fatal flaw in the Section 1031 Exchange law.
The term “Qualified Intermediary” was chosen by the IRS to refer to the independent third party holding your Net Sales Proceeds.
“Qualified” does not mean that they are actually QUALIFIED.
“Qualified” means that they are not disqualified by being your agent or a member of your family.
“Qualified” means that it is OK for them to handle these funds, but does not mean that they are actually qualified to do so.
A Qualified Intermediary is not licensed, registered, regulated, monitored or audited.
It just means that they have your money because you have signed an agreement with them.
Your funds are usually held by the Qualified Intermediary in their name, in a commingled account with the Exchange funds of other taxpayers.
These funds are sometimes lost or stolen by the Qualified Intermediary.
And these lost and stolen funds are not by small, fly-by-night operators. Read on.
If you are not completely familiar with the process of Section 1031 Exchange, go to our home page and review it.
It's Like A Seminar In A Book
IF YOU USE A DELAWARE STATUTORY TRUST, TRIPLE NET LEASE, OR A T-I-C, YOU MUST HAVE THIS EDITION.
MISSING FUNDS AND THE QUALIFIED INTERMEDIARY
On November 24, 2008, LandAmerica 1031 Exchange Services, Inc. (LES), one of the five largest Qualified Intermediaries in the country, filed for bankruptcy, and that froze all of the customers’ funds being held for closings.
LES claimed that the total value of the customers’ funds was sufficient to cover the planned closings, just that the funds were invested in “auction grade securities” and that “due to a recent freeze in the credit market” the funds were not liquid.
But LES customers believed that their funds would be released at the first meeting of the Bankruptcy Court.
The truth was somewhat more disturbing.
In fact, the market for auction grade securities had collapsed.
And on the same day that LES filed bankruptcy, the parent company of LES, LandAmerica Financial Group, a Fortune 500 company and the third largest Title Company in America, possibly realizing the size of the problem and knowing that it had guaranteed some of LES’s obligation to the Exchange clients, also filed for bankruptcy protection.
It turned out that LES was holding about $450M in funds for scheduled Section 1031 Exchange closings for about 450 customers.
And the Bankruptcy Court was not releasing any of the money.
Most of the customers’ Section 1031 Exchanges had already failed by the time the Bankruptcy Court, five months later, ruled that $400M of the customers’ funds were actually owned by LES, and would be used to pay the company’s debts to secured creditors.
The remaining $50M would be used to pay the unsecured claims against the company, which included the claims of the customers who had previously owned the money.
ESCROW ACCOUNT SAFETY WITH A QUALIFIED INTERMEDIARY
So, how do you protect yourself?
I hope you are enjoying this free content.
The remainder of this content, plus additional content, is available in my book “How To Do A Section 1031 Like Kind Exchange: Simultaneous, Delayed, Reverse, Construction” available at Amazon.com/dp/B01MY433L6.
And if you are dealing with a Triple Net Lease, Delaware Statutory Trust, or a Tenancy-In-Common property, you need the OMNIBUS EDITION at Amazon.com/dp/B07BJLZNZN.
Or you can see all ten of my books on Real Estate Investing at Amazon.com/author/michaellantrip.
And I am re-writing all of this content for use on my Blog at MichaelLantrip.com, where it has already started appearing.