How a Qualified Intermediary Faciliates a 1031 Exchange

The Role of a Qualified Intermediary in a 1031 Exchange

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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. Learn more about qualified intermediaries and how to find one.

Key Takeaways

  • A 1031 exchange allows you to avoid capital gains tax by immediately reinvesting money from an asset sale into another "like-kind" asset purchase.
  • You will need a qualified intermediary to complete this exchange.
  • This qualified intermediary sells the property on your behalf and handles the new purchase for you in accordance with IRS guidelines.
  • A QI cannot be your parents, children, siblings, or agent, and they should have experience handling these transactions.

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. For example, you would have a $25,000 gain if you purchased an asset for $75,000 and later sold 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. Unless you can find someone to directly exchange properties with you (which is highly unlikely), you'll also need a qualified intermediary.

In the past, Section 1031 exchanges could be used for machinery, vehicles, artwork, patents, and other personal and intangible property. The Tax Cuts and Jobs Act changed Section 1031 to apply only to real property as of January 1, 2018.

Who Can Serve as Your Qualified Intermediary?

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.

Beyond those requirements, there are no specific rules for who can be your qualified intermediary. Due to the complexities of 1031 exchanges, however, it's best to choose an individual or business with experience in these exchanges.

An exception exists if your agent hasn't represented you within the last two years.

Qualified Intermediary 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 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.

A qualified intermediary will serve in numerous capacities during a 1031 exchange, including:

  • Coordinating with the seller and any advisor on the structure of the 1031 exchange
  • Preparing documentation concerning the relinquished asset and the replacement property
  • Providing instructions and the appropriate documents to the escrow or title company concerning the exchange
  • Creating an arms-length transaction in the agreement between the seller or exchanger and the qualified intermediary
  • Taking control of the funds from the sale of the relinquished property and depositing these funds into a separate and insured account
  • Preventing the seller from taking constructive receipt of the funds from the sale
  • Holding the funds from the sale of the relinquished property during the 45-day identification period
  • Receiving and holding the written information about potential replacement properties
  • Transferring funds for the purchase when the replacement asset has been selected and disbursing them to the title or escrow company for its purchase
  • Acquiring the replacement property in the QI's name and conveying title to the seller or exchanger by deed
  • Submitting a complete accounting of the 1031 exchange for the seller's records
  • Submitting a 1099 to the seller or exchanger and the IRS for any interest earned

IRS rules provide for businesses that are specifically devoted to 1031 exchanges, many of which are affiliated with title companies.

Finding a Qualified Intermediary

Ask for references before hiring a professional qualified intermediary, and make sure the individual has errors and omissions 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. You can also search for a member of the Federation of Exchange Accommodators, which is a professional organization for qualified intermediaries.