Naturally there are a host of great advantages to purchasing a 1031 Exchange Property. This type of property attracts a number of investors because it is similar to being the recipient of an interest free loan from the government. Of course, in order to engage in a 1031 transaction properly, the services of a qualified intermediary is highly recommended. This is a must, and not an option. However, the field of 1031 intermediary management is not a heavily regulated field. In fact, intermediaries are presently not required to be licensed, nor do they need to submit to audits. Because of these lax requirements, it is important to be a smart 1031 buyer and investor. In order to start, you must ask your intermediary the right questions. Here are three examples that you should strongly consider:
- Do you maintain errors and omissions coverage?
The first question to ask your 1031 exchange intermediary would be if they maintain errors and omissions coverage. 1031 intermediaries have a threefold purpose: they are responsible for preparing any legal documents related to your 1031 transaction, they hold the required funds until the transaction occurs, and finally they also advise you on the best way to structure and carry out your particular 1031 transaction. This is highly specific, technical process, and mistakes can and do occur. If your sale doesn’t go through, it could easily cost you tens of thousands of dollars. However, if an agent has errors and omissions coverage they can provide you with a type of insurance policy should an error occur. This type of coverage is expensive and not easy to get, however this benefit can separate the average intermediaries from the experts.
2. Do you have fidelity bond insurance to guard against embezzlement or employee theft? Is this
coverage per occurrence or is it in aggregate?
Theft and embezzlement is a very rare occurrence among 1031 intermediaries. However, it’s not a bad idea to ask what type of internal controls, audits and checks and balances they might have. One crucial step is to ask if they have fidelity bond insurance. This type of insurance can help protect you from an unscrupulous employee of the firm. It is also important to ask if the insurance is per occurrence, which means that the firm is covered up to a certain amount per occurrence of theft or embezzlement. Aggregate insurance can be a bit riskier because the amount of insurance is the total amount available for a 12month period. If the 1031 intermediary has had a particularly bad year, the insurance available could have reached its limit and have been all cashed in. Needless to say, “per occurrence” is definitely a better option.
3. Are the exchange funds held in escrow to ensure they cannot be attacked by creditors in the event of a bankruptcy?
Although it is highly unlikely that a 1031 exchange intermediary will file bankruptcy, it is a wise move to ask how financially strong the firm is. In order to protect your funds, the best case scenario is that they will be held in a qualified escrow or trust account.
These are all important questions to ask regarding this investment. You can be successful at the 1031 acquisition process as long as you properly educate yourself beforehand.