1031 Exchange Intermediary

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“It is common for people to forget about choosing a qualified intermediary (a.k.a., an exchange “accommodator” or “facilitator” when they are closing on the sale of their property. It’s a question of whether they’re all the same. Aren’t all qualified intermediaries qualified? The answer is no.”

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1031 Exchange Intermediary

In the following guide to selecting a 1031-qualified intermediary, we explain what a 1031 Exchange Intermediary is and give you questions to ask before selecting one. The key questions will prepare you for a brief conversation with a 1031 facilitator you’re considering.


Qualified Intermediary

It is an entity that prepares documentation supporting a taxpayer’s intent to initiate a tax-deferred exchange under Section 1031 and holds the exchange proceeds to preserve principal and liquidity.

Qualified Intermediaries provide input, help taxpayers understand the mechanics of a 1031 exchange, and interface with title companies or closing attorneys to ensure that the closing statement reflects the exchange.


1031 Exchange Intermediary’s Role

To administer a successful 1031 Exchange transaction, qualified intermediaries must handle several essential elements, including:

  1. To structure a 1031 Exchange transaction properly. They must prepare the 1031 Exchange agreements and related transactional documents and
  2. Receive, hold, and safeguard your 1031 Exchange funds during the transaction;
  3. Advising or consulting with you and your professional advisors to ensure compliance with all applicable Internal Revenue Codes, Treasury Regulations, Revenue Rulings, and Revenue Procedures regarding implementing your 1031 Exchange transaction.


Why 1031 Exchanges?

Real estate and improvements are subject to capital gain and depreciation recapture taxes. Suppose they are held for an investment or productive use by a business and then sold. According to some states, such as California, aggregate taxes can amount to 40 percent.

It is possible to defer tax until the replacement property sells when the taxpayer engages a 1031 intermediary. Follows 1031 exchange rules and replaces the net sales price with real property used in a productive manner or for investment. An interest-free loan of $160,000 can continue indefinitely if a condominium sells for $400,000.

From January 1, 2018, the 1031 tax code changed from including tangible and intangible personal property to just real property under the 2018 tax law. The 1031 tax code no longer allows for the use of business aircraft, equipment, collectibles, rental cars, and franchise rights.


Can You Give Me an Example of a 1031 Exchange?

In the last seven years, Kim bought an apartment building worth $2 million, double what she paid. She’s happy when her agent tells her about a $2.5 million condominium that fetches higher rents in an area.

In theory, Kim could use the 1031 exchange to sell her apartment building and then use the proceeds to buy a larger replacement home without worrying about immediate tax liabilities. As a result of deferring capital gains taxes and recapture taxes, she will have more money to invest in the new property.


A 1031 Exchange Requires A Qualified Intermediary, Right?

There is no need for a Qualified Intermediary in a “pure” exchange in which only two parties are involved: the Taxpayer and the Buyer. We need a qualified intermediary between the taxpayer, the buyer, and the seller of the new property exchange. By the 1031 code, g (6) constructive receipt limitations prevent the taxpayer from touching the exchange funds or net equity from the sale.

We can create an escrow account with a bank or financial institution by the Qualified Intermediary. It holds the funds until one of the following conditions occurs:

  • After the property transfer, the 46th day of the calendar waits for a replacement property, and candidates aren’t available.
  • On the 180th day of the calendar, the Qualified Intermediary needs to determine the candidates for replacement properties.


Is There Anyone Who Disqualifies Them From Acting As A Qualified Intermediary?

A disqualified person cannot act as a Qualified Intermediary if we consider them the taxpayer’s agent at the exchange time. Qualified agents must be independent third parties.

During the period ending two years before the date of the transaction, a 1031 exchange agent is a person who serves as:

  • The taxpayer’s employee,
  • Attorney, accountant,
  • Investment banker,
  • Or real estate broker.

This rule sometimes does not apply to financial institutions or title and escrow companies. It provides taxpayers with routine financial and title insurance, escrow, and trust services.


Intermediary for a taxpayer

In the two years before a transaction, an attorney or CPA cannot serve as a qualified intermediary for a taxpayer if the attorney or CPA has provided legal or financial services to that taxpayer unless the exchange seeks to qualify for 1031 tax deferrals.

Some CPAs and attorneys have accommodated exchanges despite providing non-exchange services to taxpayers in the past two years. By doing so, they deprive their clients of the safe harbor provisions of the exchange regulations. This will be considered an ethical violation or malpractice.


Qualified Intermediaries and 1031 Exchanges


Qualified Intermediaries and 1031 Exchanges


Exchanging Requirements

First American Exchange (such as an approved intermediary) is the first step in a 1031 exchange. This creates exchange documents that need signing before transfer. A taxable sale and subsequent purchase will occur if these documents do not exist before closing.

It is also necessary for the closing agent or buyer to send the exchange proceeds directly to the qualified intermediary, not the taxpayer or their agent. The taxpayer must contact First American Exchange when ready to get replacement property and sign extra exchange documents before the closing.


Requirements for all taxpayers

The same taxpayer must hold the replacement property as the relinquished property. Tax purposes disregarded limited liability companies with just one member. Therefore, if a taxpayer sells the relinquished property in his name. He can get the replacement property under the name of a single-member LLC.

Grantor (revocable) trusts are the same. Due to the disregarded nature of revocable trusts for tax purposes. A taxpayer can sell his relinquished property and buy the replacement property in his trust’s name.


Need for Qualified Purposes

A taxpayer cannot relinquish a personal residence or a replacement property if used in their business or as an investment.


Requirements of Like-Kind

There is no limitation on how much gain can be deferred on the relinquished property if replaced with like-kind property.


Exchange of fully deferred shares

Taxpayers must satisfy the following conditions to receive total deferral of gain and tax liabilities:

  • Purchase replacement property on the same or higher valuation as the relinquished property;
  • Obtain a replacement property and reinvest all the equity of the relinquished property;
  • Acquire only like-kind properties.

A taxpayer will be liable for tax consequences, including the initial down payment if these requirements do not apply.


A tax on boot

A tax on boot is the amount of gain you receive as a result of an exchange or the amount of debt you pay off on the relinquished property that does not go along with an equal or more significant amount of debt on your replacement property (or offset by the injection of cash).

Sometimes, taxpayers can defer some gains if they receive a boot. However, if they receive more boots than they gain, an exchange does not offer any benefit.


Transfer the relinquished property to related parties.

A taxpayer can generally transfer the relinquished property to related parties. Provided both parties hold the acquired property for at least two years. Unless the related party is also doing an exchange, the taxpayer cannot get replacement property from a related party.


Identify the intermediary

A taxpayer must identify to the 1031 exchange intermediaries or other permitted person within 45 days of transferring the first relinquished property the potential replacement properties they may be able to acquire through the exchange within 45 days. The taxpayer must sign the identification in writing. It is necessary to identify the properties, and the deadline is absolute.

The three-property or 200% rule identification may apply to identify replacement properties. Or the 95% exception may apply if these two rules do not apply.

Whenever the identification notice expires, the taxpayer must also sign it in writing and deliver it to the person who has to send it within the identification period.


The deadline for taxpayers to get their replacement property

The earlier of the following two dates is the deadline for taxpayers to get their replacement property:

  • Upon transfer of the relinquished property, 180 days must pass.
  • In addition, the taxpayer needs to file a tax return for the year of transfer.

There is no extension for holidays or weekends to this deadline.


Improvement exchanges and reverse exchanges

First American Exchange Company can assist in facilitating reverse exchanges or improvement exchanges for taxpayers who need to acquire replacement property before transferring their relinquished property.

First, the American Exchange Company can assist if the taxpayer wants to use the exchange proceeds to improve the target replacement property to balance the exchange. The taxpayer must perform due diligence on the property to be “parked” and hold the title during the exchange.

In addition to the standard exchange fees, title-holding fees apply, so taxpayers must determine the tax benefits of reverse and improvement exchanges before paying these additional fees.


An ineligible person

Those who do not qualify cannot serve as an intermediary for a taxpayer. These include relatives and those who work for the taxpayer, attorneys (for non-exchange related services), accountants, real estate agents or brokers, or investment bankers or brokers within two years of the exchange.


Intermediaries with qualifications

All intermediaries are not created equal. A qualified intermediary can be anyone who does not have a disqualifying condition. First American Exchange Company has all these characteristics, including:

  • A good reputation in the industry,
  • Experience,
  • Nationwide services,
  • And proven financial stability.

Taxpayers should exercise caution when selecting a company.


Questions about Qualified Intermediary?

Who can be a qualified intermediary for 1031 exchange? Here are some questions to ask when considering engaging a qualified intermediary near me:


What is the expertise of the QI?

What experience does the QI have with exchanges? Is there a Certified Exchange Specialist on their staff? Is this their full-time occupation or part-time? Know whom you trust with your funds and with your documents regarding the exchange.


What is the protection of the exchange proceeds?

A variety of types of security are available to protect the funds. There is a $250,000 maximum FDIC insurance limit per account. Is a Qualified Escrow Agreement used? Which need dual signatures from the taxpayer and the Qualified Intermediary to allow the disbursements?


Is the Qualified Intermediary accessible?

If QI is available after hours or on weekends, what are the office hours?


How much does a Qualified Intermediary charge?

Generally, qualified intermediaries charge a flat fee or a part of the selling price. The interest earned on exchange proceeds can be split among the exchangers and the Qualified Intermediary or all to the Exchanger. The Exchanger receives a minimum interest rate equal to the 13-week Treasury rate if the exchange proceeds exceed $2,000,000.


How Do You Proceed Now That You’ve Chosen a Qualified Intermediary?

How to find a qualified intermediary? We’ll start by talking about when you should choose a qualified intermediary/like kind exchange intermediary. Before selling your relinquished property, choose your QI. QIs should be involved early in the process.

When a QI is in place, the exchanger signs agreement documents with the QI, and the 1031 exchange process officially begins. Unless these documents are ready before the closing of the relinquished property. The exchangers may be in a taxable sale, not a 1031 exchange.

When the exchange process begins, the exchanger and his agent must avoid interacting with the sale proceeds. Lastly, the QI should complete these documents before closing the replacement property. Send any proceeds to the closing agent or buyer so you can wire them to the QI.


Some important deadlines to consider

Additionally, there are some important deadlines to consider when acquiring a replacement property.

  • After 180 days from the date of transfer, the relinquished property is no longer yours.
  • The relinquished property was transferred by the taxpayer’s tax return due date during the year. It is important to note that weekend and holiday extensions are not available.


Qualified Intermediaries: How to Find One

The Federation of Exchange Accommodators (FEA) is an association that represents hundreds of Qualified Intermediaries. All members are subjected to a criminal background check and abide by an Ethics Policy.

Because the 1031 tax deferral is a federal law, Qualified Intermediaries can accommodate exchanges according to their location. When a Qualified Intermediary adheres to state regulations, it can accommodate exchanges worldwide.

Hedy Ghavidel

HEDY GHAVIDEL Managing Attorney  Roseville Office  1-866-471-6981  info@attorneysre.com Bio...

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