The potential benefits of employing a 1031 exchange in your investment strategy are attractive. However, as with many appealing tools, investors should be careful and precise in using this one. Since structuring a real estate transaction using the exchange offers the opportunity to defer capital gains taxes, the IRS requires that taxpayers follow the rules precisely.
Notable among the IRS requirements for the successful execution of a 1031 exchange is the use of a Qualified Intermediary, sometimes called an Exchange Accommodator. The person or entity fulfilling the QI role is a key player in the transaction. The Qualified Intermediary is responsible for several critical aspects of the exchange, including:
- Oversight of the forms required. This function includes the formal identification of potential replacement properties. The investor must convey the identification of potential acquisition targets to the QI within 45 days after the sale of the original property. The QI also maintains a record of how the funds from the initial sale are used and manages the preparation of 1099 forms.
- Holding the funds from the sale in escrow. Again, it's vital that the taxpayer not have access to these funds during the process. That means the QI must carefully oversee the account and facilitate the purchase of replacement property using those funds.
What are the requirements for a Qualified Intermediary?
The IRS details what and who a QI may not be but does not offer instructions for what they should be. Qualified Intermediaries are not regulated, although they may belong to the Federation of Exchange Accommodators. The QI cannot be any of the following:
- The taxpayer
- Related to the taxpayer
- Employed by or the employer of the taxpayer
- An agent of the taxpayer (including investment banker or broker, attorney, or accountant)
While there are no specific requirements for the entity performing the function, the investor should look for a QI with experience. The investor may want to ask specific questions about the number and type of exchanges that a QI (whether individual or company) has conducted. It’s also prudent to inquire about the QI’s internal controls and how client funds are held.
Is it acceptable to use the title company?
Generally speaking, yes. The title company in a transaction should have the experience and knowledge to complete the exchange successfully. For example, title companies typically hold purchase funds in escrow and can do the same to facilitate a 1031 exchange. In addition, the title company is familiar with clearing access to the title and the forms that the IRS will need.
For a 1031 exchange to succeed, the QI must ensure that the transaction takes place within the required timeline, that all identification rules are adhered to, and that the necessary forms are completed and transmitted.
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. It should also not be construed as advice meeting the particular investment needs of any investor.
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.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
