Should the Federal Trade Commission develop national licensing requirements and standards regulating the middlemen who conduct thousands of tax-deferred real estate exchanges every year?
Are the financial dangers so great for investors in the booming exchange industry that so-called “qualified intermediaries” need to be reined in and forced to submit to strict federal oversight?
Last week the FTC acknowledged that there have been a number of incidents where intermediaries have caused significant financial harm to real estate investors.
Examples of wrongdoing included cases where intermediaries -- who are entrusted by exchangers to manage escrow funds that often are in the millions of dollars -- have pilfered money from the escrows, spent it for their own purposes, or simply stole it and disappeared.
In a tax-deferred exchange under Internal Revenue Code Section1031, real estate investors can trade properties for “like kind” investment real estate without immediate tax recognition of gains that otherwise would be taxable.
An investor might sell an apartment building at a big profit but have the proceeds deposited into an escrow account under the control of an intermediary. Later, when the investor has identified a suitable exchange property to acquire, the escrowed funds would be released.
As long as the investor does not receive or control the escrowed proceeds and meets other requirements, the IRS will defer capital gains taxes indefinitely.
But the Federation of Exchange Accommodators, a group representing intermediaries and other exchange industry players, says that too often in recent years, unethical intermediaries have not lived up to their contractual responsibilities.
That, in turn, reflects badly on the vast majority of industry members who are honest, competent and put their clients' interests first. Part of the problem, according to the group, is that the intermediary industry has no uniform oversight or regulation across the country.
In a petition to the FTC, the federation asked that the agency create national standards for intermediaries so that investors will have greater confidence that their escrowed funds are in safe hands.
The group sent the FTC details of 23 incidents of fraud and theft. But the agency said that while it recognizes that there have been periodic problems, it is not in a position to assume national oversight of the industry.
Bottom line for real estate investors contemplating tax-deferred exchanges: Look hard and long into the financial backgrounds and references of the intermediaries you employ.
After all, you're putting large amounts of money in their hands -- and you can't take the risk that there's larceny in their hearts.