Selecting a 1031 intermediary is something that should not be taken lightly as selecting the wrong one could be extremely detrimental. It is important to keep in mind that they will be the ones that maintain custody of your equity during the 1031 exchange process and therefore having a solid understanding of the intermediary firm that you will be working with is crucial.
There are five specific areas that need to be explored during an investors selection process.
Financial Condition – It is extremely important to consider the financial condition of the intermediary. It is often the case that intermediaries are owned by title companies and banks. It is still important to vet the ownership entity to ensure that they are financially sound and ideally one would look to select an intermediary with the strongest balance sheet.
Bonds and Insurance – It is important to consider whether an intermediary has a fidelity bond and errors and omissions insurance coverage. Although maintaining these would be considered good business practices, it is important that an investor does not rely on these items too much.
Regulated Entities – It is important to seek to use an intermediary that is regulated. Although there exists no federal regulation or licensing of intermediaries and state regulation is minimal, using institutions that are subject to banking or title insurance regulation is something that should be strongly considered. These institutions have a greater set of checks and balances that they must abide by from a regulation standpoint.
Investment Funds – Knowing where you money is being invested while in the hands of the intermediary is critical. In an unregulated environment, there exists the danger that money can be invested in illiquid and risky assets and therefore the funds may not be available when they are needed for the exchange. Furthermore, due to the competition in this space, some intermediary firms may invest in funds more aggressively to generate a better yield for the investors and to stand out from their peers. Although investors like greater yields, in exchange situations it is important that the capital is available when needed and should therefore be invested more conservatively.
Separation of Funds – Exchange funds should never be comingled with an intermediary’s operating funds. Additionally, as a further layer of protection, an intermediary should establish separate exchange accounts in the name of each taxpayer rather then comingle. By keeping funds separate, the exchange funds should not be accessible to creditors should the intermediary go insolvent.