1031 exchange: Due diligence when recommending a QI

1031 exchanges are on the rise in the northeast and Mid-Atlantic for many reasons. The significant increase in capital gain rates in 2013 is a contributing factor as is the appreciation investors are seeing in these markets. But investors seeking to perform a 1031 exchange should exercise caution in selecting a qualified intermediary (QI) as all are not equal by any means and a poor selection can result in the exchange being disqualified on audit or worse, the loss of funds. Although a small number of states have enacted regulations governing IRC Section 1031 exchange QI companies, there are no federal regulations regarding QI's and the safeguarding of exchange funds. It is important for both the taxpayer and the taxpayer's tax/legal advisors to perform due diligence before choosing a QI company. The importance of this can be seen in Winters v. Dowdall (Winters v. Dowdall 63 A.D. 3d 650 (2009) 882 N.Y.S. 2d 100). In that case, the taxpayer sold a relinquished property in N.Y. and retained Patrick Dowdall, of the law firm Dowdall and Associates, P.C., purported experts in the field, to provide guidance with their 1031 exchange, and specifically with the selection of a QI. Dowdall selected Atlantic Exchange Co., LLC (AEC) to act as QI. During the course of the exchange, the taxpayer's proceeds were stolen by AEC and Edward Okun, AEC's sole member. The taxpayer's loss was over $604,000. The taxpayer argued that his loss was caused by Dowdall's legal malpractice, including: * Failure to properly investigate AEC before selecting them as QI; * Failure to confirm that AEC was sufficiently bonded before recommending AEC as the QI; and * Failure to confirm that the taxpayer's exchange proceeds were deposited into an account on behalf of the taxpayer as required by the terms of the exchange agreement. The court determined that Dowdall did not adhere to their duty to perform sufficient due diligence because they did not sufficiently investigate the QI prior to recommending the QI to the taxpayer. Dowdall had represented that they were experts on the subject of 1031 tax-deferred exchanges, and the taxpayer had relied upon these representations in hiring Dowdall. The court determined that the advice given by Dowdall was negligent, and was the cause of the damage to the taxpayer. Tax, legal and financial advisors should realize the importance of performing sufficient due diligence before recommending a QI to facilitate a 1031 exchange on behalf of their clients. This due diligence should consist of an examination of the practices of the QI regarding the handling of client funds, and the security measures offered by the QI in the event of loss. Asset Preservation, Inc.'s (API) adheres to consistent and disciplined practices in handling exchanger funds, overseen by its parent company Stewart Title. API maintains fidelity bond coverage, and errors and omissions insurance coverage. API has implemented protections for its customers that go far beyond the typical protections offered by many other QIs. API's parent company, Stewart Title, provides a "letter of assurance" guaranteeing the performance of API. In API's 24 years, there have been no claims on this letter of assurance. Find out more about API's security of proceeds - what we call The API Advantage. Pamela Michaels, Esq., is an attorney and VP and Scott Saunders is a senior VP of Asset Preservation, Inc., New York, N.Y.