The recent bankruptcy filings by LandAmerica Financial Group and LandAmerica 1031 Exchange Services reinforce the diligence that real estate
purchasers and 1031 investors need to take in order to protect their escrow deposits and 1031 funds. As part of this diligence, real estate
purchasers and 1031 investors need to be aware of the various types of protections available as well as the limitations thereon.
Recent Changes in FDIC Deposit Insurance Coverage
Deposits at institutions insured by the Federal Deposit Insurance Corporation are insured up to $250,000 per depositor until December 31, 2009,
after which, deposit insurance for deposit accounts will return to $100,000 per depositor per insured bank. Recently, however, the FDIC
announced its temporary Transaction Account Guarantee Program, which provides full coverage for non-interest bearing transaction deposit accounts
at FDIC-insured institutions that agree to participate in the Temporary Liquidity Guarantee Program. The transaction account guarantee applies
to all personal and business checking deposit accounts that do not earn interest at participating institutions. This unlimited insurance
coverage is also temporary and will remain in effect for participating institutions until December 31, 2009.
Maximizing FDIC Deposit Insurance Coverage
The current $250,000 deposit insurance limitation applies to all accounts held by a depositor at an insured financial institution—regardless of
whether or not the accounts are located in different branches of that particular financial institution. Therefore, depositors need to ascertain
which bank their escrow agent will use in order to ensure (i) that the bank is FDIC insured and (ii) their earnest money deposits will not
exceed the maximum insurance limitation when combined with their existing accounts at that particular bank, if any.
If, prior to December 31, 2009, the total amount of earnest money a depositor plans to deposit with an escrow agent either (i) exceeds $250,000,
or (ii) when combined with that depositor's existing accounts, would cause the depositor's total deposits to exceed $250,000, then that
depositor should request that the escrow agent deposit its earnest money in a non-interest bearing transaction account at an institution
participating in the FDIC's Temporary Liquidity Guarantee Program. By doing so, a depositor can take advantage of the Transaction Account
Guarantee Program which will fully insure its earnest money deposit.
Commingled Deposit Accounts Held by the Escrow Agent
If an escrow agent commingles earnest money deposits, each depositor's individual deposit can still be insured up to the maximum amount,
provided, however, that the account qualifies as a fiduciary account. In order for a deposit account to qualify as a fiduciary account, the
fiduciary nature of the account must be disclosed in the bank's deposit account records (e.g. "First Real Estate Title Company, Client Escrow
Account"). The name and ownership interest of each owner must be ascertainable from the deposit account records of the insured bank or from
records maintained by the escrow agent. Assuming the disclosure requirements are satisfied, the deposits of each depositor will be insured
as that depositor's deposits. If the requirements are not satisfied, then the entire account will be subject to the $250,000 limitation rather
than each individual deposit.
Therefore, when selecting an escrow agent, it would be prudent to determine (i) whether funds will be placed in a separate account or commingled
with other earnest money deposits and (ii) in the latter case, whether the account will qualify as a fiduciary account.
Maximizing Protection for 1031 Funds
Because many 1031 transactions involve deposits in excess of the maximum FDIC insurance coverage amounts, investors involved in 1031 exchanges
will need to take additional precautions to ensure that their investment funds are afforded proper protection. Below are several different
precautions investors should consider when entering into an exchange agreement with a 1031 exchange Qualified Intermediary.
First and foremost, investors should request that their exchange funds be placed in segregated accounts. If the exchange funds become
commingled with any funds belonging to the Qualified Intermediary and the Qualified Intermediary files or is forced into bankruptcy, the
exchange funds could become part of the bankruptcy estate of the Qualified Intermediary, whereupon, the investor would become an unsecured
creditor of the Qualified Intermediary.
Investors should also determine how the Qualified Intermediary will handle their exchange funds (e.g. will they be placed in deposit accounts
or invested in securities). The types of accounts or investments in which the Qualified Intermediary places exchange funds will have a direct
impact on the security of the funds. Higher yield investments, such as the auction rate security investments that ultimately led to the failure
of Land America 1031 Exchange Services, entail a greater risk to your funds.
In order to avoid such risks, investors can request that the Qualified Intermediary invest the exchange funds in a non-interest bearing
transaction account at an institution participating in the FDIC's Temporary Liquidity Guarantee Program. This will allow the investor to take
advantage of the FDIC's Transaction Account Guarantee Program, which will fully insure its exchange funds through December 31, 2009.
Alternatively, investors who wish to invest in interest bearing accounts can request that their exchange funds be collateralized by government
backed securities or secured by a surety bond. The availability of these alternatives may vary among different financial institutions.
The risk avoidance measures discussed in this e-Alert are not exhaustive, and the availability of the foregoing measures may be limited depending
upon the escrow agent or Qualified Intermediary selected. Your JW
Real Estate attorneys and
Tax attorneys would be happy to work with you to
accomplish your 1031 exchange or to advise you on how to best protect your funds. If you have any questions regarding this e-Alert, please
contact Clark Pulliam at 214.953.5720 or
cspulliam@jw.com.
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