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California to Regulate Qualified Intermediaries Next Year

July 5, 2015 CGS3 General

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California to Regulate Qualified Intermediaries Next Year

October 16, 2008
By Phillip L. Jelsma

Beginning January 1, 2009, Senate Bill 1007 imposes certain good practices requirements on qualified intermediaries holding funds for tax-free exchanges doing business in California. Although the legislation does not require any registration or licensing with the State, significant consequences may result for failure to comply with its provisions.

SB 1007 defines an exchange facilitator (“EF”) as a person who does any of the following:

  1. Maintains an office in the State for purposes of soliciting businesses as an exchange facilitator; or
  2. Holds itself out as a exchange facilitator by advertising or soliciting customers.
  3. Facilitates for a fee an exchange of like kind property through an agreement with a taxpayer to:
  • Sell the taxpayer’s property that is being relinquished in California;
  • Take title to the property in the State on behalf of the taxpayer as an exchange accommodation title holder; or
  • Act as a qualified intermediary or qualified escrow holder


An exchange facilitator does not include any of the following:

  • A taxpayer or disqualified person under Treasury Regulation § 1.1031;
  • A financial institution that is not facilitating exchanges, but is acting solely as a depository for exchange funds, a qualified escrow holder or qualified trustee;
  • A title company or escrow company not facilitating exchanges;
  • A person that teaches professionals about tax-deferred exchanges or trains them to act as exchange facilitators;
  • A qualified intermediary who holds exchange funds from the disposition of relinquished property outside the state; or
  • An entity which is an exchange accommodation title holder that holds a 100% ownership interest and is used to take title to the property.


The exchange facilitator would be required to notify its clients in writing within ten days of the effective date of any change in control.

In addition, the exchange facilitator needs to satisfy one of the following requirements:

  • Maintain a fidelity bond of at least $1 million executed by an insurer qualified to do business in California;
  • Deposit cash or securities or an irrevocable letter of credit or an interest-bearing account of at least $1 million; or
  • Deposit all exchange funds in a qualified escrow or qualified trust and provide any withdrawals from the account would require both the client and the exchange facilitator’s written authorization.


Further, the exchange facilitator needs to maintain errors and omissions insurance of at least $250,000 executed by an insurance admitted to do business in California or deposit cash, securities or an irrevocable letter of credit of at least $250,000 in an interest bearing account or money market account with a financial institution. The exchange facilitator would be charged as a custodian on all exchange funds and invest in a fashion that meets the prudent person standard, and satisfy investment goals and liquidity and preservation of principal. The prudent person standard would be violated if any of the following occurs:

  • Exchange funds are knowingly commingled with the exchange facilitator’s operating account;
  • Exchange funds are loaned or otherwise transferred to any person or entity affiliated with or related to the exchange facilitator; or
  • Exchange funds are invested in a manner which does not provide sufficient liquidity to meet the exchange facilitator’s contractual obligations to its clients and does not preserve the principal of the exchange funds.


SB 1007 provides that exchange funds shall not be subject to execution or attachment on any claim against the exchange facilitator and provides that the exchange facilitator shall not knowingly keep or cause any money in any bank, credit union or other financial institution under a name designating the money as belonging to a client of the exchange facilitator or unless the money belongs to a client and was actually entrusted to the exchange facilitator by that client.

Finally, the exchange facilitator would be prohibited from any of the following:

  • Making any material misrepresentations that are intended to mislead concerning like kind exchange transactions;
  • Pursuing and continuing or flagrant misrepresentation or making false statements;
  • Failing, within a reasonable time, to account for any monies or property belonging to others that may be in the possession or control under the exchange facilitator; or
  • Engaging in any conduct constituting fraudulent or dishonest dealings;
  • Committing any crime involving fraud, misrepresentation, deceit, embezzlement, misappropriation of funds, robbery or theft; or
  • Materially failing to fulfill its contractual duties to the client to deliver funds unless the failure is due to circumstances beyond control of the exchange facilitator.