Regulations issued by the U.S. Treasury Department in 1991 require the use of a facilitator in an exchange. The facilitator cannot be a "disqualified person" within a two year period of the exchange, hence your employee, attorney, accountant, investment banker, real estate agent or broker cannot coordinate your 1031 Exchange.

As a result, a new class of professionals has become established over the last 15 years. They are known by several names:

1. Exchange Accommodators
2. Exchange Coordinators
3. Exchange Facilitators
4. Qualified Intermediaries (QI)

The same treasury regulations also specify that an Exchanger, wishing to be completely tax deferred, is prohibited from receiving actual or constructive receipt of any cash proceeds during the exchange. Funds must be held by the qualified intermediary. Regulations do not specify how the funds are to be held and kept secure; therefore, each exchanger should at least ask the following security questions of any prospective Qualified Intermediary they are considering:

1. Do you have a current Fidelity Bond?
2. Do you have a current Errors & Omissions Liability Policy?
3. What is your Investment Policy?
4. Where do you Keep Trust Funds?
5. What professional experience do you have?

The purpose of this paper is to help illustrate what the answers to these five questions should look like. We have used our firm's answers as the illustration.

1. Do you have evidence of a current Fidelity Bond? Every reputable qualified intermediary should have such a fidelity bond. The Fidelity Bond insures against losses resulting from dishonest acts, such as embezzlement, conversion, fraud, etc. of the insured's employees against the Exchanger. A sample of what evidence of an insurance certificate for a Fidelity Bond looks like follows.
   
   
   
   Note the following when reviewing a Fidelity Bond Program certificate.
   Insured's Name: Make sure it is the actual or d.b.a. name of your QI.
   Effective Period: Fidelity Bonds are only good for one year & must be renewed.
   Amount of Coverage: The amount of coverage is per occurrence per employee.
   The amount should be appropriate for the general size of your transactions.
   
   To obtain this type of insurance, the qualified intermediary must answer a series of questions on the application that ask about such things as: bank account segregation, facilitation agreements, discrepancies, and other internal controls. The purpose of such a bond is to transfer the risk of fraud away from the Exchanger to the financial strength of an A-rated insurance carrier.
   
   
2. Do you have evidence of a current Errors & Omissions Liability Policy?This is another important insurance policy for qualified intermediaries. It differs from a Fidelity Bond, and both should be maintained in order to shift the maximum risk from the Exchanger. Every reputable qualified intermediary should have such insurance, which defends and pays valid claims alleging negligent acts, errors or omissions in the provision of, or failure to provide, professional services involving or related to 1031 exchange transactions, subject to the terms and conditions of the policy.
   
   
   
   Note that the Errors & Omissions Liability policy is also an annual policy that must be renewed each year. It used to provide a nice one page certificate that summarized the key points, but now just has a cover letter. The purpose of this type of liability policy is again to transfer the risk of negligence away from the Exchanger to the financial strength of an A-rated insurance carrier.
3. What is your Investment Policy? Although a formal investment policy statement is not required, it would be prudent for an Exchanger to know how their funds may be invested.
   
   
   
   
4. Where are Trust Funds Deposited? After determining how trust funds are invested, the next questions to ask are, Where are they invested and why? There are no regulations that specify answers to these questions.
   Where? 1031 Exchange Coordinators invests trust funds into Frontier Bank, unless directed otherwise for extraordinary and rare reasons by a client or for banking safety circumstances. (http://www.frontierbank.com)
   Why? This answer is more elaborate, but helps prospective clients understand the value of a solid a banking relationship.
   
   
   
   What Do you do Differently Now? This day and age of banking requires a new level of constant vigilance that was not previously required. We do that at 1031 Exchange Coordinators by checking the news, linking with other banking professionals who are watching the news, holding quarterly meetings and conference calls with Frontier Bank officials, reviewing the quarterly FDIC report and being sensitive to the economic climate in the Northwest. One of the reasons we are with Frontier Bank is that they are in Western Washington where we can notice personally what the economic climate is. They also are invested mostly in real estate which we know about in the Northwest. We diversified some of the trust fund proceeds in the fall of 2008 when banks appeared to be failing. We also have relationships with other banks which we are renewing.
   
   Recent Calls? The response in recent calls from Frontier has been as follows: (a) We lend to mostly real estate and small business in Western Washington state so we are vulnerable to those industries, (b) We are currently encouraging customers who are behind to sell if they can to someone they know and get the loan paid off, if not (c) we have set up a special credits department to concentrate on troubled loans. Other comments include (d) We made no sub-prime loans, but (e) we are increasing our loss reserves, (f) we are well capitalized at the moment, (g) we need deposits like everyone else and have picked up an influx from Washington Mutual, (h) we believe that we can withstand these economic times.
   
   Recent News? Frontier kept itself pretty much out of bad news except for a few articles about their stock being shorted until March of 2009 when an FDIC examination concluded and an FDIC order demanded that Frontier (NASDAQ: FTBK) strengthen its management, increase directors' participation in oversight of the bank, and closely supervise efforts to upgrade the bank's loan portfolio. Frontier officials responded by saying the bank was "heavily impacted by the sharp downturn in the economy and the Northwest housing market." They added they signed the agreement with the FDIC and they're "working to address items cited in the examination and (the bank) intends to fully comply with the terms of the agreement." Some steps cited by the officials include selling assets, eliminating bank board meeting fees, eliminating the bank's dividend, freezing some salaries, instituting a hiring freeze and reducing executive salaries.
   
   So caution must be used whenever funds exceed $250,000 in any one bank.
   
   
5. What professional experience do you have? Qualified Intermediaries come from a variety of backgrounds. Many individuals may be capable of facilitating the simplest routine exchanges. However, more complex situations could arise with little or no warning. Aligning oneself with an Intermediary who has a strong Real Estate, Tax or Legal background can help ensure that exchanges run smoothly and that hurdles can be overcome. Ask what professional organizations your QI belongs to and what degrees/designations they hold. 1031 Exchange Coordinators boast a diverse and very experienced staff including key executives with credentials: D. Richard Dance, CPA and a Certified Exchange Specialist; We are active as the chairman of Continuing Education for the national Federation of Exchange Accommodators. We continuously teach real estate professionals. We testify before the Treasury Department, Internal Revenue Service, and Small Business Administration on proposed tax regulations. We serve on the state committee that is working with WA State legislation to regulate exchange facilitators in 2008.

Summary

These five questions are not meant to be the only questions that should be asked when selecting a Qualified Intermediary, but they are some fundamental ones that tend to give a glimpse into the security of your exchange funds. In addition to these critical questions, an exchanger should seek referrals from their trusted tax, legal and financial advisors who have dealt with the 1031 exchange firm before and know of their competence and integrity in financial matters. Selecting a QI is an important step in a successful exchange transaction. Exchange coordination is a very specialized financial and tax service designed to insure smooth and successful exchange transactions and provide security for the exchange funds. Your Qualified Intermediary should be a partner you can trust in an exchange transaction for both competent advice and security.

If we can help you understand any more about security of exchange funds and how to protect them, please give us a call. We would be happy to assist you any way that we can.