A 1031 exchange allows investors to swap one investment property for another to defer all capital gains taxes. However, there are strict rules and timelines that investors must follow (including who can facilitate an exchange) to complete an exchange.
While a CPA is certainly a trusted financial adviser and may be knowledgeable of the 1031 exchange process and rules, they cannot act as your Qualified Intermediary (QI) in a 1031 exchange.
The Basics of a 1031 Exchange
The 1031 exchange gets its name from Section 1031 of the U.S. Internal Revenue Code. The 1031 exchange allows investors to relinquish investment properties and use the proceeds to purchase “like-kind” replacement properties, where like-kind is broadly defined as property held for investment or business purposes.
Investors can defer tax liabilities indefinitely if they continue to reinvest capital back into real property. The like-kind exchange can potentially enable investors to build wealth by keeping their dollars at work and allowing equity to grow tax-deferred over an extended period of time.
Can a CPA Do a 1031 Exchange?
While it may be tempting to ask your CPA to act as your Qualified Intermediary, a CPA cannot facilitate a 1031 exchange between investors. Under IRC Section 1031 guidelines, CPAs, attorneys, investment bankers, and real estate agents/brokers fall under the ‘agent’ category.
According to the IRS, there are strict rules regarding who can be your Qualified Intermediary — family members, employees, financial connections, or agents of the taxpayer are excluded.
However, there are exceptions. Agents who perform routine financial services, such as forming trusts, creating escrow accounts, or securing title insurance, are permitted to become Qualified Intermediaries.
The Role of the Qualified Intermediary
The Qualified Intermediary is key in a 1031 exchange. The only time they are not required is if funds are processed on the same day; however, there's the potential risk that the wire transfer won't be completed on time, which could disqualify the exchange.
The QI has many responsibilities in an exchange, including:
- Ensuring the exchanger remains in compliance with IRS guidelines
- Holds the proceeds from the sale of the relinquished property in escrow
- Completes all documentation relating to the exchanger's identification of replacement property or properties
- Facilitates the purchase of the replacement property by transferring funds to the title company/seller
Anyone who doesn’t fall into the categories listed above can be your Qualified Intermediary. To be qualified, they must apply for Qualified Intermediary status, which involves receiving a QI-EIN. This is a number assigned to the QI by the IRS.
Finding the right QI to make sure you stay in compliance and to guide you throughout the exchange is crucial. Before selecting a QI, make sure that they have not been financially connected to you within the past two years and that they are not a relative, employee, or agent. If you do try to use your CPA in a 1031 exchange, you may be required to pay fines and the IRS will disqualify the exchange for preferential tax treatment.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure. There is no guarantee that the investment objectives of any particular program will be achieved. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits.
