How a Qualified Intermediary Faciliates a 1031 Exchange
The Role of a Qualified Intermediary in a 1031 Exchange
A successful 1031 exchange isn't a do-it-yourself project. You must follow IRS rules to realize the tax deferral benefits, and you'll need a middle person, called a qualified intermediary (QI).
QIs are sometimes referred to as an exchange accommodators or facilitators.
What Is a 1031 Exchange?
You would normally pay capital gains tax on any profits you realize when you invest in a property, hold it for a period of time, then sell it. You would have a $25,000 gain if you purchased an asset for $75,000 and later disposed of it for $100,000.
A 1031 exchange allows you to reinvest that money in a "like kind" asset and dodge the capital gains tax bullet until you eventually sell the subsequent property and fail to do another 1031 exchange. You're essentially deferring the tax under Internal Revenue Code Section 1031(a)(1).
Time limits apply, and the subsequent property must be of equal or greater value than the asset you sold. You'll also need a qualified intermediary.
Who Can Serve as Your QI?
IRS Section 1031 specifies that neither your parents, your children, nor your siblings can act as your middle person. It also prohibits anyone from serving who's regarded as your "agent." This might be your attorney, broker, CPA, or real estate agent.
An exception exists if your agent hasn't represented you within the last two years.
Overview of a QI's Responsibilities
A qualified intermediary sells your property on your behalf, buys the replacement asset, then transfers the deed to you. It's the QI's responsibility to hold the proceeds, prepare the legal documents, and attempt to ensure that the transaction is completed within IRS guidelines.
The seller must execute a written agreement with the qualified intermediary before closing on the sale of the existing property. This preserves tax deferral benefits and completes a successful 1031 exchange.
The existing property is referred to as the relinquished property.
Qualified Intermediary's Services
A qualified intermediary will serve in numerous capacities during a 1031 exchange:
- Coordinate with the seller and any adviser on the structure of the 1031 exchange.
- Prepare documentation concerning the relinquished asset and the replacement property.
- Provide instructions and the appropriate documents to the escrow or title company concerning the exchange.
- Create an arm’s length transaction in the agreement between the seller or exchanger and the qualified intermediary.
- Transfer the property to the QI, who then conveys the asset to the buyer.
- Take control of the funds from the sale of the relinquished property and deposit these funds into a separate and insured account.
- Prevent the seller from taking constructive receipt of the funds from the sale.
- Hold the funds from the sale of the relinquished property during the 45-day identification period.
- Receive and hold the written information about potential replacement properties.
- Transfer funds for the purchase when the replacement asset has been selected and disburse them to the title or escrow company for its purchase.
- Acquire the replacement property in the QI's name and convey title to the seller or exchanger by deed.
- Submit a complete accounting of the 1031 exchange for the seller's records.
- Submit a 1099 to the seller or exchanger and the IRS for any interest earned.
Finding a QI
Ask for references before you hire a professional qualified intermediary, and make sure the individual has errors and omissions insurance, plus fidelity insurance, to protect you against fraud or negligence.
An easy way to find a qualified intermediary is to ask your local escrow officer for a recommendation.
IRS rules provide for businesses that are specifically devoted to 1031 exchanges, many of which are affiliated with title companies.
A word from the author: This material is neither an offer to sell nor the solicitation to purchase any security. The information is for discussion and information purposes only. It is not intended to replace competent legal, tax, or financial planning advice. The applicable tax codes apply to and relate to federal law only. Individual states may have their own additional tax codes. Please contact the appropriate tax and legal professional in your state. This information is provided from sources believed to be reliable but should be used in conjunction with professional advice that is consistent with your personal situation.