It is always interesting to learn from other people’s mistakes. In the following circumstances both the
company and the client gained valuable insight on what to do differently next time. Whenever a court
case makes the headlines, we know we should sit up and pay attention, especially when over
$100,000 is at stake.
Our story starts when a title company decided to help its client out by not only acting as the title
insurer and the escrow closer, but also the Qualified Intermediary to facilitate their client’s 1031
Exchange transaction. The same staff was responsible for all duties involved – a one stop shop if you
will. Sounds good so far, right?
The client/Exchanger told the title company that they intended to Exchange a $765,000 relinquished
property for replacement property consisting of vacant land valued at $356,160 which would then have
a warehouse built on it – something that is commonly referred to as an Improvement or Build to Suit
Exchange. With this type of transaction the taxpayer cannot take title to the replacement property until
the improvements are complete (or as close to completion as possible within the 180 day time frame
allowed). The property would normally get “parked” under a separate entity through the Qualified
Intermediary during this time. Instead of executing paperwork for ”parking” the property, the title
company went ahead and drafted up paperwork for a standard Delayed Exchange – mistake #1!
The title company, wearing both the Qualified Intermediary and Escrow Agent hats, prepared both the
exchange and closing documents, which were presented to the client/Exchanger at the respective
closings a few days apart. When at the closing for the vacant land, title was transferred from the seller
directly to the client/Exchanger. At this point the Improvement/Build to Suit transaction was
ruined. The title should have been transferred to an entity created uniquely for this
purpose. Unfortunately, this ended the client/Exchanger’s opportunity to use their remaining
exchange funds to build the warehouse they wanted and resulted in them having to face significant tax
consequences – major mistake #2!
Additionally, the title company’s Escrow Closer/ Exchange Coordinator permitted the Exchanger to sign a
blank Identification form (used to identify replacement property). They told the client/Exchanger that they
would fill in the description of the replacement property at a later date. They inserted the legal description of
the vacant land, but did not identify any improvements to be built – which is another necessary step for those
improvements to qualify for the Exchange process. They also did not ask the Exchanger if they wanted to
identify any additional replacement properties – mistake #3 (this is also considered tax fraud by the IRS)!
The title company did not provide copies to the client/Exchanger of the replacement deed or the completed
Identification form until about 2 ½ months after the closings. This goes way outside the Exchange guidelines
of the 45-day deadline for an Exchanger to identify any additional replacement property – simply bad
practice.
Finally, the title company that acted as the title insurer, escrow closing agent and Qualified Intermediary with
the same staff responsible for all duties in all capacities, was taken to court. The trial court held that the title
company acting as a Qualified Intermediary was negligent and failed to exercise reasonable and ordinary
care in the conduct of its duties under the Exchange Agreement. Damages of approximately $122,000 were
awarded to the client/Exchanger to compensate them for the additional taxes they incurred.
So let’s ask what is the lesson to be learned? This case emphasizes the danger of dabbling in an area of
business that can have many complicated nuances. The risks greatly outweighed the rewards as the client/
Exchanger learned in the situation above. Anyone thinking about executing a 1031 Exchange should choose
a Qualified Intermediary carefully. Experience, security and financial strength should be the cornerstones of
choice. For both the client/Exchanger and the title company, this was an expensive lesson.
