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 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.
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 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:
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.