What to Look For in a Qualified Intermediary

Recent news about 1031 exchange accommodators filing bankruptcy or committing fraud with client funds has highlighted the need to carefully select a Qualified Intermediary. Today we'll focus on what items a taxpayer should look at when selecting a QI.

Most important in selecting a Qualified Intermediary is security of funds. When interviewing or researching exchange providers, one should look first and foremost to the financial backing of the company. Not all Qualified Intermediaries have the financial capacity should a problem occcur with the funds they hold. Many are small shops owned by an individual, CPA or law firm. These individual owner providers rely on the honesty and ethics of one or a few individuals. In addition, these individuals may not have the financial capacity to recover should some issue surface within the operation.

Seeking a 1031 exchange provider that is backed by a bank, title company or publically-traded company provides a level of security. If the QI has financial problems, the parent company is there to absorb any losses. In most cases, the exchange business is a relatively small piece of these larger entities and losses can be easily addressed with the financial capacity of the parent. In addition, working with a bank or title subsidiary adds a level of confidence that the QI has greater security measures (checks and balances and separation of duties) within its operation. These controls minimize the ability of one employee to commit fraud. In addition, most bank or title-owned QIs have conservative investment policies that prohibit the QI from speculating on the principal or investing in riskier investments.

One should also ask to the level of fidelity bonding (essentially insurance) that the QI maintains. Most larger QIs will have substantial policies of $10, $25 or $50 million to protect client money. Still, a potential client should not go too far in relying solely on the fidelity bonding. First, it is a policy of the company that protects the client only if the company makes a claim against the bond. In other words, the owner, not the client will be the one to make the claim against the bond. Second, most bonding is on a 'per occurance' basis. Most fidelity bonding is often misinterpreted as a 'per transaction' bonding. So, if the company you have chosen has a $1 million bond but is holding $5 million, there is essentially a 20 cents on the dollar bonding coverage.

Another important security measure is the investment of the exchange funds held in trust. This is important in that, while you have an exchange agreement with a QI, the funds are technically their funds during the exchange period. If the owner of the Qualified Intermediary decides to invest in a high risk hedge fund or wildcat oil project losing the principal, your claim is protected by the exchange agreement alone. It is important to know where your exchange funds are invested. How safe is your principal and how accessible is information about the investment of those funds?

As an additional measure, some QIs place each client's funds in a segregated account. Others pool the funds in an investment account. If problems occur with the funds, pooling is protected only by the exchange company's internal subaccount journal entries. Segregated accounts provide a clearer picture that the funds held in that account are for the benefit of a specific client. While the account will be in the name of the exchange intermediary, it can specified by notating or naming the account for that client.

Safety is of utmost importance in selecting an exchange accommodator. While Qualified Intermediaries must also posses the professional knowledge and customer service that you would expect from a financial partner, your first screening should involve safety. After all, all the expert advice and friendliness in the world will not replace your money if the QI fails.

If you would like further information about What to Look for in a Qualified Intermediary, please contact any of the professionals at 1031 Corporation.