A 1031 exchange is a detailed real estate transaction that, when executed properly, may allow for the deferral of capital gains taxes. The complexity of the process stems from the many rules the IRS has implemented to prevent abuse. One of these requirements is working with a qualified intermediary sometimes referred to as an accommodator.
Your qualified intermediary plays a major role in the exchange. But what if they fail to to fulfill their responsibilities or if concerns arise about the security of the proceeds? Can qualified intermediaries be replaced during an exchange? Yes, but it’s a complex answer. Below, Realized 1031 dives deeper to help you understand what can happen.
Refresher on the Role of a Qualified Intermediary
Working with an accommodator during a 1031 exchange is necessary per IRS rules because the service has strict requirements on who can handle the proceeds from the sale of the relinquished property. Particularly, the taxpayer cannot have direct control of the funds to prevent constructive receipt, even briefly. This act will result in the loss of their tax deferral status.
Beyond this central function, qualified intermediaries often provide support with:
- Preparing and managing required exchange documentation
- Assigning rights under purchase and sale agreements
- Coordinating with closing agents
- Reviewing identified replacement properties for procedural compliance
Given the extensive role of the qualified intermediary, it is generally advisable to work with a single, vetted QI throughout the transaction. However, there are scenarios when replacement becomes necessary.
Qualified Intermediary Replacement: When Is It Possible?
The IRS doesn’t have any language or stipulations preventing the replacement of a qualified intermediary during an exchange, so changing yours is possible. There is one thing you’ll have to follow no matter what: you cannot take constructive receipt of the funds during the transition. Otherwise, you’ll trigger a taxable event. As such, it’s important to work with an attorney or tax advisor if you have plans to remove or replace your accommodator.
What are scenarios that warrant such a rare event? Here are some examples.
- Fraud or Insolvency: If the intermediary hid their insolvency or other financial issues, then a court may allow the appointment of a new accommodator.
- Breach of Contract: There are cases when the qualified intermediary fails to perform their duties. In such scenarios, replacement is allowed, but you must be careful to avoid triggering a taxable event.
- Mutual Agreement: In rare instances, both the facilitator (also known as qualified intermediaries) and the investor may agree to part ways due to issues such as miscommunication, administrative concerns, or compliance problems discovered late into the transaction.
Preventing the Need to Replace a Qualified Intermediary
The scenarios above may be mitigated—and the likelihood of needing to replace your accommodator reduced — by thoroughly vetting them before entering a contract. Check for references, insurance coverage, and track records to help assess the firm’s reliability. Requesting audited financial statements can also offer additional insight into the intermediary’s financial stability. Investors are encouraged to consult with a qualified tax advisor or 1031 exchange professional when selecting a qualified intermediary.
Wrapping Up: Is It Possible to Replace My 1031 Exchange Intermediary?
Yes, under certain circumstances, it may be possible to replace a 1031 exchange accommodator. This is a rare practice and best done under the guidance of tax advisors or 1031 exchange experts. The most important thing is to never gain direct control of the property sale proceeds to maintain your tax-deferred status.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
Sources:
https://www.business.com/articles/audited-financial-statement/
