Buying a 1031 transaction, as well as advise you how to comply with all IRS rules and regulations.
Due to the technical complexity of carrying out a 1031 transaction, it is much more likely for a mistake to occur due to human error, than through theft and embezzlement. What’s even worse is that these types of mistakes are hard to catch, even with various internal controls and processes put in place to prevent them.
Furthermore, errors and omissions coverage is difficult to get and quite expensive, and as a result many intermediaries do not carry this type of insurance. However, any mistakes that occur could result in a refusal to allow your 1031 exchange to go through – which could cost you tens of thousands of dollars.
In order to protect your funds, ask a prospective intermediary to provide a copy of the insurance binder so that you can check the insurance underwriter, policy limit, and the expiration date of the policy. In addition, it’s always wise to ask for the phone number of the agent so that you can verify that insurance coverage is in full force and that the information in the insurance binder is accurate and complete.
DO YOU MAINTAIN FIDELITY BOND COVERAGE TO INSURE AGAINST EMPLOYEE THEFT OR EMBEZZLEMENT? IF YOU DO, WHAT IS THE LIMIT OF THE COVERAGE AND IS IT PER OCCURRENCE OR IN AGGREGATE?
Theft and embezzlement are actually quite rare among qualified institutional 1031 intermediaries. However, you should always check that an intermediary has not only established a full set of internal controls, independent audits, and various checks and balances, but also carries fidelity bond insurance coverage.
Fidelity bond insurance coverage, also known as “honesty bonds,” are a form of insurance that protect your funds against theft or embezzlement by an employee. In addition to requesting a copy of the insurance binder with the policy’s insurance underwriter, policy limit, and the expiration date of the policy, you should also check whether or not coverage is per occurrence or in aggregate.
Insurance that is “per occurrence” means that the intermediary is covered up to a certain amount per occurrence of theft of embezzlement. If your intermediary carries this type of insurance, you’ll want to make sure the amount is sufficient to cover the funds you plan on entrusting with the intermediary.
“In aggregate” refers to the policy’s limit for the entire year. This type of insurance is riskier, since you have no way of knowing if or how much of the policy has been cashed in for that year.
ARE ALL 1031 EXCHANGE FUNDS HELD IN QUALIFIED ESCROW OR QUALIFIED TRUST ACCOUNTS TO ENSURE THAT THEY CANNOT BE ATTACHED BY YOUR CREDITORS IF YOU FILE BANKRUPTCY?
It’s important to check if the company is financially strong. However, even the most financially secure companies are may be forced to file bankruptcy, as was seen with Hurricane Katrina.
In in the unlikely event that your intermediary is forced to file for bankruptcy, your funds are considered part of the company’s assets, and can be pursued by creditors. In order to protect your funds, ask your intermediary whether or not your exchange funds will be held in a qualified escrow or preferably, qualified trust account.
Here’s a summary of questions you can use when interviewing prospective 1031 property exchange intermediaries:
- How many years have you been administering 1031 Exchange transactions?
- How many 1031 Exchanges have you administered (individual 1031 Exchange officer and 1031 Exchange Qualified Intermediary)?
- Do you hold clients’ 1031 Exchange funds in a segregated Qualified Trust Account or a Qualified Escrow Account?
- Do you maintain fidelity bond insurance coverage to insure against employee theft, embezzlement or misappropriation of the 1031 Exchange funds?
- What is the policy limit of your fidelity bond coverage?
- Is your fidelity bond coverage “per occurrence” or merely “in aggregate”?
- Will you provide me with copies of your insurance binders and the contact information for your insurance agents so I can verify that your insurance coverage is still in full force and effect?
- Do you maintain sufficient errors and omissions (E&O) insurance coverage to insure against any 1031 Exchange Qualified Intermediary error or omission?
- What is the policy limit of your errors and omissions insurance coverage?
- Do your fidelity bond and errors and omissions (E&O) insurance policies cover just the 1031 Exchange Qualified Intermediary or do they also cover numerous other related entity operations that might diminish the overall protection to me in the event of multiple losses throughout the consolidated entity such as title insurance, escrow, etc.?
- What type of internal processes and internal audit controls have you implemented to protect my 1031 Exchange assets?
- Do your 1031 Exchange administrators call me prior to the disbursement of my 1031 Exchange funds to ensure that I want the funds disbursed (as opposed to disbursing when escrow calls)?
- Where are my 1031 Exchange funds held or invested?
- What type of specific investments do you use for my 1031 Exchange funds?
Still unsure which intermediary to choose?
At Westwood Net Lease Advisors, we maintain relationships with several highly qualified companies that experience has shown to be honest and efficient.