Professional Responsibility

This chapter is written to Maryland's rules because that is the jurisdiction this work addresses. The federal tax provisions apply everywhere, and the conduct rules of most States follow the Model Rules closely enough that the analysis transfers, but the citations do not, and one Maryland provision examined at 56.5 differs from the Model Rule in a way that matters.

56.1 Attorney as intermediary: the disqualification bar

The client will ask, and the answer is almost always no.

A person who has acted as the taxpayer's attorney within the two year period ending on the date of the transfer of the first of the relinquished properties is treated as an agent of the taxpayer at the time of the transaction, and is therefore a disqualified person.¹ A qualified intermediary must not be a disqualified person.²

The rule is narrower than the slogan and should be stated accurately, as 28.3 develops. An attorney is disqualified by prior representation, not by being an attorney. Services performed with respect to exchanges intended to qualify under section 1031 are excluded from the lookback,³ so an attorney whose only work for the taxpayer in the period was exchange work is not disqualified on that ground, and an attorney who has never represented the taxpayer is not disqualified at all.

The second order rule catches the firm. A person who bears a relationship described in section 267(b) or section 707(b)(1) to a disqualified person, substituting ten percent for fifty percent, is also disqualified.⁴ An exchange entity owned by the taxpayer's law firm is therefore disqualified where the firm is, and the regulation's own example turns on whether ownership exceeds ten percent.⁵

Being disqualified does not disable the lawyer from the engagement. It disables the lawyer from three specific roles: serving as the qualified intermediary, holding the funds as escrow holder or trustee, and receiving the identification. Everything else remains available. The lawyer may structure the exchange, draft and review every document of Chapter 52, negotiate with the intermediary, and advise throughout. Clients conflate the two constantly and should be told the difference in the engagement letter.

Where a firm proposes to affiliate with an exchange entity, a separate rule applies in addition to the tax analysis. An attorney is subject to the rules of professional conduct with respect to the provision of law-related services where those services are provided by the attorney in circumstances not distinct from the provision of legal services, or where they are provided by an entity the attorney controls and the attorney fails to take reasonable measures to assure that the recipient knows the services are not legal services and that the protections of the client-attorney relationship do not exist.⁶ Law-related services means services that might reasonably be performed in conjunction with and are in substance related to legal services, and that are not the unauthorized practice of law when provided by a non-attorney.⁷

Exchange facilitation is law-related services within that definition. A firm that controls an exchange entity therefore carries the conduct rules into it unless it takes the reasonable measures the rule requires, and the disqualified person analysis above may make the arrangement unusable for the firm's own clients in any event.

56.2 Conflicts in representing multiple exchange parties

An exchange involves a taxpayer, a buyer, a seller, an intermediary, and frequently a lender and one or more entities the taxpayer owns with others. A lawyer will be asked to represent more than one of them.

The governing standard. An attorney must not represent a client if the representation involves a conflict of interest, which exists if the representation of one client will be directly adverse to another, or if there is a significant risk that the representation of one or more clients will be materially limited by the attorney's responsibilities to another client, a former client, or a third person, or by a personal interest of the attorney.⁸

Representation is nonetheless permitted where the attorney reasonably believes competent and diligent representation can be provided to each affected client, the representation is not prohibited by law, it does not involve one client asserting a claim against another in the same proceeding, and each affected client gives informed consent, confirmed in writing.⁹

The same analysis governs practice before the Service, in nearly identical language, with the added requirement that written confirmation be obtained no later than thirty days after informed consent and that copies of the consents be retained for at least thirty six months after the representation concludes.¹⁰

Four recurring situations in exchange practice.

The taxpayer and the other side of a transaction. Directly adverse in the ordinary case, and the ordinary answer is no.

Multiple partners in a drop and swap. This is the hard one and it recurs constantly. The partners who will exchange and the partner who wants cash have divergent interests: the structure that best protects the exchanging partners lengthens the time before the cashing-out partner is paid, and the timing that best serves the cashing-out partner is what invites the step transaction argument of 42.1. A lawyer who represents the partnership and each partner has a significant risk of material limitation as to every one of them.

The partnership and its partners. Chapter 20 established that the partnership is the taxpayer and the partners are not. Advice that is correct for the entity may be adverse to a particular partner, and the entity's interests should be identified as such at the outset.

A personal interest of the attorney. Where the lawyer or the firm has any economic relationship with an intermediary, a fund sponsor, or a replacement property offering, the personal interest branch of the rule is engaged directly. A referral arrangement that pays the firm is a conflict requiring informed consent confirmed in writing, and it is also the arrangement most likely to be reconstructed unfavorably years later.

The practical discipline is to identify the client in the engagement letter, name who is not the client, and obtain the writing before the relinquished property closes rather than when a dispute emerges. Consent obtained after the fact is worth less, and the file that shows the question was considered contemporaneously is worth a great deal.

56.3 Competence and the duty to refer

An attorney must provide competent representation, which requires the legal knowledge, skill, thoroughness, and preparation reasonably necessary for the representation.¹¹ The rule's own commentary directs attention to the relative complexity and specialized nature of the matter, the attorney's training and experience in the field, the preparation and study the attorney is able to give it, and whether it is feasible to refer the matter to, or associate or consult with, another attorney.¹²

That last factor is the operative one in exchange practice, and this work exists in part because the subject rewards it.

The federal standards point the same direction and add specificity. A practitioner must exercise due diligence in preparing or assisting in the preparation of returns and other papers relating to Service matters, in determining the correctness of representations made to the Treasury, and in determining the correctness of representations made to clients with reference to any matter administered by the Service.¹³ Reliance on another person's work product is presumed diligent only where the practitioner used reasonable care in engaging, supervising, training, and evaluating that person.¹⁴

Written advice carries its own standards. A practitioner must base written advice on reasonable factual and legal assumptions, reasonably consider all relevant facts and circumstances known or that should be known, use reasonable efforts to identify and ascertain the relevant facts, decline to rely on representations where reliance would be unreasonable, and relate applicable law and authorities to facts.¹⁵

And one prohibition deserves separate mention because it forecloses a form of reasoning that appears in exchange planning more often than anyone admits. In evaluating a federal tax matter, the practitioner must not take into account the possibility that a tax return will not be audited.¹⁶

Return positions have their own floor. A practitioner may not willfully, recklessly, or through gross incompetence sign a return containing a position that lacks a reasonable basis, or advise a client to take such a position or prepare a portion of a return containing one.¹⁷

What competence requires in this field, concretely. The failures catalogued in this work are not exotic. They are a late identification, an identification sent to the wrong person, an unrevoked earlier list, a missed assignment notice, a foreign seller identified at the settlement table, a related party in the chain, an unmodeled boot figure. Each of them is avoidable by a practitioner who knows the field and unavoidable by one who does not, and the reasonable practice for a lawyer who does not is to associate with one who does or to refer.

56.4 Malpractice exposure in blown deadlines

Exchange deadlines produce an unusually clean malpractice claim, and understanding why is the beginning of managing the risk.

The elements assemble themselves. The deadline is fixed by regulation and cannot be extended, as 26.3 establishes. Whether it was met is a documentary fact. The damages are computable to the dollar under Chapter 37, being the tax that would have been deferred, plus interest, plus any penalty. There is rarely a dispute about causation, because the deadline either was met or was not.

The deadlines that produce claims, in rough order of frequency, are those this work has flagged as unforgiving.

The forty five day identification, including its manner, its recipient, its numerical limits, and the requirement that an amended list revoke the earlier one. Chapter 25.

The written assignment notice to all parties on or before the date of transfer. A single day deadline with no cure. 24.3 and 52.2.

The one hundred eighty day period as truncated by the return due date, and the extension that preserves it. 26.2.

The withholding certificate application for a foreign seller, which must be submitted on or before the closing date. 48.2.

The qualified exchange accommodation agreement, due within five business days after the titleholder takes title, which is the one deadline in this field that runs forward. 52.2.

The two year related party monitoring obligation and its annual reporting. 40.3.

The depreciation election, due by the extended due date of the return for the year of replacement, with the relief examined at 53.4 available only within limits.

Three measures reduce the exposure and none is expensive.

Calendar every date at the relinquished closing, confirm them to the client in writing, and work to internal dates several days earlier. Do not adopt the intermediary's computation without verifying it, as 26.3 counsels; the intermediary's error becomes the lawyer's problem.

Define the scope of the engagement in writing. A lawyer engaged to draft documents has a different obligation from one engaged to monitor deadlines, and the client's understanding of which was retained is formed by the engagement letter or by hindsight.

Write the boot computation down before closing. A client who recognizes gain because the transaction was structured as it was, and who was told the number in advance, has a bad outcome. A client who learns the number from a return preparer has a claim, whether or not it is a good one.

One further point about the client relationship. Where a client insists on a structure the lawyer has advised against, and the lawyer proceeds, the advice and the client's decision should both be recorded in writing at the time. That record is the file's answer to a question that will be asked years later by someone with the benefit of the outcome.

56.5 Advertising and solicitation constraints

An attorney must not make a false or misleading communication about the attorney or the attorney's services. A communication is false or misleading if it contains a material misrepresentation of fact or law or omits a fact necessary to make the statement as a whole not materially misleading, if it is likely to create an unjustified expectation about results the attorney can achieve or states or implies that results can be achieved by means violating the rules or other law, or if it compares the attorney's services with other attorneys' services where the comparison cannot be factually substantiated.¹⁸

That rule governs all communications about an attorney's services, including advertising and permitted direct contact.¹⁹

One Maryland provision differs from the Model Rule and should be read carefully by anyone marketing an exchange practice. An attorney may communicate the fact that the attorney does or does not practice in particular fields of law, subject to the truthfulness rule. But an attorney shall not hold himself or herself out publicly as a specialist.²⁰ The single exception is the patent practice designation.²¹

The distinction is between describing a field of practice and claiming a status. Stating that a firm practices in like-kind exchanges, or practices only in that field, is permitted. Publicly holding oneself out as a specialist is not, and the constraint reaches website copy, directory listings, and marketing materials as readily as it reaches an advertisement.

Three applications specific to this field.

Outcome claims. Statements about deferral achieved for prior clients, or about amounts of tax saved, run directly into the prohibition on communications likely to create unjustified expectations about results. The commentary to the rule addresses that category expressly.

Guarantees. An exchange depends on facts the lawyer does not control, including deadlines the client must meet and property the client must find. A communication implying that the outcome is assured is misleading on its face.

Affiliated services. Where a firm markets both legal services and exchange facilitation, the law-related services rule of 56.1 requires reasonable measures to assure the recipient understands that the facilitation is not legal services and that the protections of the client-attorney relationship do not apply.²² Marketing that blurs the two is the circumstance the rule was written for.

The synthesis for Part X. The lawyer's exposure in this field is concentrated in three places: a deadline that cannot be extended, a client who did not understand the tax consequence before it was incurred, and a role the lawyer was not permitted to occupy. Each of the three is addressed by the same instrument, which is a written record made at the time, and this work has recommended it in nearly every chapter for that reason.