At the beginning of the year, Southwest Exchange out of Henderson, Nevada, filed for bankruptcy after losing $100 million of their clients’ money. And this spring, local intermediary IXG and its sister companies in the 1031 Tax Group went down when they were unable to account for $150 million in client funds.

by Gary Gorman founding partner, 1031 Exchange Experts, LLC

Most intermediaries put all of their exchange funds into one account, called a “commingled” or a “pooled” account. For years I’ve been writing articles, warning about the potential problems inherent in commingling 1031 exchange funds. And for years I’ve been the piñata of the exchange industry. I’ve been threatened with lawsuits and have been told by other intermediaries to: 'shut up and quit needlessly scaring the public about commingled accounts...!'

Now after these latest problems, all of which are the result of intermediaries commingling exchange accounts, you’d think that taxpayers would finally get it and be concerned about their money. But to my utter, utter amazement they are not! Most of the calls we get about our exchange services are from taxpayers who are more concerned about the exchange fee than about the security of their funds. Pretty generally, exchange fees in Colorado range from about $500 to about $750. So compared to the capital gain taxes deferred, or the integrity of the QI, we’re not talking about a lot of money. And yet taxpayers seem to be much more focused on that $250 difference than they are on the security of their funds. Even though my company, The 1031 Exchange Experts, is already the largest independent qualified intermediary in Colorado, I believe we could double or triple our business, and vastly increase our profits, if I dropped our fee to $400 and simply kept all my client’s interest! But that isn't moral, ethical, or in the best financial interest of my clients.

“...shut up and quit scaring the public about commingled accounts...!”

Human nature astounds me. Or maybe it’s our society; we are so accustomed to someone watching out for us that we automatically assume that such is the case with 1031 exchanges and qualified intermediaries. It is not! Your massage therapist has to go to school for a year before they can touch your back, and you must have a license to be a pedicurist and cut someone’s toenails. Yet your intermediary can handle your exchange and hold your money without being regulated or licensed by anyone. It is time (past time?) that intermediaries are regulated. It doesn’t really matter whether the State or the Federal government does it, but intermediaries need to be regulated on at least two levels.

First, there should be barriers to those trying to enter the industry that have no business being there. Intermediaries need to prove their technical experience. They need to know what they are doing and they need to have experience in the industry before they are allowed to handle your exchange.

But most important, the way they handle your money needs to be regulated. Separate, segregated accounts must be a requirement—and segregated must mean truly segregated. One of the many things that are coming out of the IXG mess is that they apparently told some of their clients they were setting up segregated accounts. In fact, the accounts were merely sub-accounts of a commingled account. Each account needs to be truly separate, and each taxpayer’s name and tax identification number (or social security number) needs to be associated with that account. Each account should also require two signatures: the taxpayer’s and the intermediaries. And the proceeds from each Colorado exchange should be required to be kept in a Colorado bank. The state should also audit the accounts and the intermediaries from time to time.

But until that happens, you still need to be very, very careful. Saving a couple of hundred dollars on the exchange fee isn’t worth it if you loose all your money. If you don’t believe that, just ask one of IXG’s former clients.