Qualified Intermediary 1031

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“If investors do not follow the rules correctly, they can suffer significant financial repercussions. 1031 Exchanges are complicated transactions that investors must follow to gain the full benefit of tax deferral. So, obtaining the support of a Qualified Intermediary, or QI, is always a good idea to help the transaction.”

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Qualified Intermediary 1031

This post will explain the following:

  • What a Qualified Intermediary 1031 is,
  • How they support 1031 Exchange Transactions,
  • And where they can find them.

Throughout this article, readers will learn about the role of a Qualified Intermediary. Which will help them conduct due diligence in their 1031 Exchange transactions.


Precisely, What Is A 1031 Exchange?

Understanding a 1031 Exchange transaction is the first step to understanding the role of QIs.

When investors sell an investment property profitably. They can defer capital gains tax liability by completing a 1031 Exchange. Also known as a Like Kind Exchange, sanctioned by tax code.


Rules to get a full tax deferral.

Investors must follow the following rules to get a full tax deferral. The following are a few examples (this list is not exhaustive):

  • Within 45 days of selling an asset, investors must identify a replacement property in writing.
  • After the relinquished property sells, investors must purchase the replacement property.
  • A business or trade must use both properties for productive purposes or investment.
  • To purchase the replacement property, return all the proceeds of the relinquished property.

Depending on the rules of a 1031 Exchange, violating one can nullify some or all of the tax deferral. This may have significant financial consequences. Investors who do not reinvest 100% of the sales proceeds into the new property are taxable because any cash is not reinvested. And deemed received as cash by the exchanger) is considered “boot,” which is taxable.

The best practice for investors is to partner with QIs to ensure they follow all 1031 rules.


Qualified intermediaries: What are they?

What is a qualified intermediary? The QI is any individual or financial institution facilitating a 1031 exchange. An individual who qualifies as a Qualified Intermediary is described explicitly in 26 CFR 1.1031(k)-1(g) (4), which states:

  • This need applies to a person who is: (A) Not the taxpayer or a disqualified person (as defined in paragraph (k) of this section);
  • The taxpayer will get (or transferred) by the exchange agreement. This requires acquiring the relinquished property and transferring the relinquished property. Obtaining the replacement property and transferring the replacement property to the taxpayer.

A 1031 Exchange is not complete without a Qualified Intermediary. In the next section, we will examine the role of the Qualified Intermediary in more detail.


Qualifications and Responsibilities of Qualified Intermediaries

Qualified Intermediaries, or QIs, are vital to safeguarding the tax-deferred status of exchanges and supporting investors through complex transactions. Below is a list of the roles and responsibilities they take on:


Exchange facilitation:

During the exchange process, a third-party intermediary acts as a neutral intermediary. It ensures that IRS regulations apply and funds and properties transfer smoothly.


Holding Funds:

Investors cannot actually or constructively receive funds from the sale of relinquished property. So, the QI holds the funds in a separate escrow account, maintaining the exchange’s tax-deferred status.


Documentation and Timing:

As part of the QI’s role, they prepare the necessary exchange documents, such as assignments and agreements. Furthermore, they ensure exchange transactions occur within the IRS’s specified timeframes. Like the identification and exchange periods.


Identification of Replacement Properties:

The QI is responsible for assisting the investor in identifying replacement properties. That meets the requirements of a like-kind exchange within the designated identification period. They may provide guidance and resources to assist investors in locating replacement properties.


Coordination with Other Professionals:

As part of the exchange, the QI collaborates with other professionals, including:

  • Attorneys,
  • Accountants,
  • Real estate agents,
  • And title companies to resolve legal and financial issues.


Compliance and Reporting:

The QI assures compliance with IRS regulations during the entire exchange process. The QI may also assist with the tax reporting requirements associated with the exchange. In addition to guiding investors through the rules and requirements of a 1031 exchange. They can guide them in understanding and fulfilling their obligations.


Communication and Help:

The QI will support the investor with any questions or concerns throughout the exchange process. They will guide them through the steps, explain the implications, and assist the investor when necessary.


Requirements for Qualified Intermediaries in 1031 Exchanges

How to become a qualified intermediary for 1031 exchanges? The Internal Revenue Code stipulates that like-kind exchanges are tax-deferred transactions. Investors can defer capital gains by using 1031 intermediary exchanges. At the same time, capital gains can be deferred by selling one piece of property and investing the proceeds in another piece of property. The investor must follow specific rules and requirements.


Requirements for Qualified Intermediaries in 1031 Exchanges


Like-Kind Property:

Like-kind property includes various types of real estate, such as:

  • Residential,
  • Commercial,
  • Vacant land is typically sold and acquired.


Qualified Intermediary:

We need a qualified intermediary, a QI, for the exchange to be successful. The QI assists in coordinating the transaction and holds the funds generated from the sale until.


Identification and Timing:

The investor must identify replacement properties within 45 days of selling the relinquished property. The investor must get a replacement property within 180 days of the due date of their tax return, including extensions.


Reinvestment of Proceeds:

The investor must reinvest the sale proceeds from the relinquished property into the replacement property to defer all capital gains taxes. You may receive cash or other property subject to tax during the exchange.


Tax Deferral:

Reinvesting proceeds into a like-kind property provides the primary benefit of 1031 exchanges. It allows the investor to defer capital gains tax liability until a future taxable event, such as a sale.


What Are the Needs for a Qualified Intermediary?

How to find a qualified intermediary? An investor needs a Qualified Intermediary when entering into a 1031 Exchange transaction. It is also essential to hire a qualified intermediary as early as possible in the 1031 Exchange process or at least as soon as possible.

By following both guidelines, investors can maximize their chances of qualifying for full tax deferral.


Qualified Intermediaries: Benefits of Hiring One

The following are extra benefits of engaging QIs/qualified intermediary capital advisors for a qualified intermediaries 1031 exchange beyond their roles and responsibilities:


Expertise and Knowledge:

To facilitate 1031 exchanges, QIs have extensive knowledge of the rules and complexities involved. By utilizing their expertise, they minimize the risk of errors with IRS guidelines during the exchange process.


Compliance and Risk Mitigation:

In the 1031 exchange process, investors must adhere to IRS regulations and procedures to ensure compliance with IRS regulations, which mitigates the risk of the exchange being invalid and its tax consequences.


Time and Resource Savings:

By delegating administrative tasks, investors can focus on other aspects of their real estate investment strategy, documentation, and strict timelines to qualified intermediaries.


Access to Network and Resources:

Qualified intermediaries often have extensive networks in the real estate industry. Their referrals can improve the investor’s support system and ensure a smoother exchange process by referring investors to other professionals like real estate agents, attorneys, and tax advisors.


Conflict Avoidance:

Using a qualified intermediary to maintain neutrality and prevent conflicts of interest between the buyer, seller, and the other parties involved in the transaction is essential. Providing an impartial intermediary for the transaction. A QI ensures that all parties act reasonably, transparently, and compliantly.


Professional Documentation and Reporting:

QIs assist investors in preparing the necessary documentation for filing with the IRS. Ensure that the exchange meets the IRS’s requirements and that it provides a clear record for future audits.


Guidance on Reinvestment Strategies:

The right intermediary can assist investors in identifying replacement properties aligned with their investment goals and offer guidance on reinvestment strategies. By utilizing their market knowledge and insights, they can help maximize the exchange’s potential benefits.


A Qualified Intermediary and a Private Equity Investment

Finding an appropriate replacement property within a relatively short timeframe can be challenging when conducting a 1031 Exchange transaction for an individual investor. To make the process easier, many choose to work with a private equity firm with the necessary resources, relationships, and property inventory.

Private equity firms and QIs work together to help investors place their 1031 property exchange proceeds.


How to Choose a 1031 Accommodator/Who can be a qualified intermediary?: Common Questions


What is the qualified intermediary’s business history?

The more experience the QI has in handling exchanges and understanding the laws and regulations governing them. The better since they have dealt with many exchanges.


In each of the last five years, how many exchanges have a QI completed, and what are the total dollars exchanged?

You can estimate the amount you must exchange by dividing each year’s dollar amount by the number of exchanges. Hopefully, this number is not significantly lower than the amount you need to exchange.


Is a QI’s business primarily delayed/forward exchanges (sell a property; or are there more complex exchanges?

An experienced firm may have superior technical prowess if it completes complex exchanges. However, CPAs and tax attorneys used by the firm are another good indicator of experience. Several firms offer these services internally. Essential QI services do not include tax advice, but these services could prove invaluable if you encounter a tax problem.


What is the method of holding my funds?

Segregated Qualified Trust Accounts or Segregated Qualified Escrow Accounts are better than two low-cost commingled accounts and QIs that promise to pay a high interest rate.


What is the location of my funds?

To keep the 1031 funds safe, placing them in a large, reputable, FDIC-insured bank is best. There is generally a $250,000 limit on FDIC insurance per account holder. The QI can be required to hold funds at another bank if you are concerned about the bank’s health.


Can you provide me with a copy of your internal controls?

Understanding the approvals, oversight, and steps required to move or release your money through internal controls is essential. They aim to protect your money from theft or fraud by firm employees. One employee should not share this authority.

Best practices require your signature and multiple written approvals within the QI’s organization to prevent one or two employees from accessing your funds. Lastly, in a reputable firm, all employees should have regular background checks conducted. Again, don’t be intimidated: a reputable firm’s internal controls should be readily available.


Is the firm insured in terms of types and amounts?

The insurance coverage of a QI protects you against theft or if you must pay taxes due to negligence on the part of the firm. To ensure the security of your account, you should have fidelity bonds and Errors & Omissions (E&O) insurance in place.

What is more important is how the QI compares their fidelity bond and E&O coverage with the average amount of funds on deposit for all of their exchangers. If the aggregate amount of exchanges obtained by Question 2 is divided by 10, 31, you can determine the average amount of funds the QI has deposited.

Suppose a QI exchanged $240 million in the last two years and held exchange funds for 120 days on average (120/365 = 3). Then, their average 1031 funds on deposit would be $80 million ($240M/3). Generally, $1 million of fidelity bonds and $250,000 of E&O insurance won’t cover $80 million, but there’s no hard and fast rule.


The 1031 Qualified Intermediary: Final Thoughts

Providing tax-deferred exchanges in real estate transactions requires the help of a qualified intermediary 1031. In addition to ensuring compliance with IRS regulations and mitigating risks, investors can confidently navigate the exchange process’s complexities by leveraging their expertise. Investors save time and money because of the QI’s knowledge, neutrality, and network.

Hedy Ghavidel

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

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