The term “relinquished property” refers to the execution of a 1031 exchange, which is a tool that investors can use to defer payment of capital gains taxes due when they sell an investment asset and reinvest the proceeds. Because the benefit can be significant, the IRS closely regulates the conduct of these exchanges.
Investors may not have access to proceeds.
One of the necessary conditions for a successful 1031 exchange is that the investor (the exchanger) may not have access to the funds paid for the relinquished property during the completion of the replacement purchase. The property the investor sells is called the relinquished property, and the property (or properties) they purchase is called the replacement property.
To ensure that the investor doesn't have practical access to the proceeds in the period between the sale of the relinquished asset and the completion of the purchase of the replacement property, the exchanger uses a Qualified Intermediary (QI) to maintain the funds, along with other responsibilities. In many cases, the exchanger and the QI will agree to a contract that assigns the subject property to the QI, referred to as the assignee. These simple contracts also include the buyer acknowledging that they will cooperate with the property transfer from the assignee (QI) to them.
Is an assignment contract always necessary?
In most cases, the contract is necessary to assure the IRS that the taxpayer completing the exchange has not had access to the proceeds from the sale of the relinquished property before the completion of the replacement property purchase. If the sale and purchase are completed on the same day, it's possible that the investor could skip this step.
However, many things can happen that might delay the sale or purchase transaction from being promptly completed. The 1031 exchange might be disqualified in that event, leaving the investor with an unexpected and unwelcome tax bill. That, in turn, could threaten their ability to complete the purchase. For that reason, many exchangers will engage a QI even if a simultaneous exchange is planned.
How can I choose a trustworthy QI to assign the property rights to?
Selecting a Qualified Intermediary is vital to pursuing a 1-031 exchange. The QI is responsible for maintaining the proceeds from the sale of the relinquished property and completing the purchase of the replacement asset. They also collect and manage the paperwork the IRS wants to see to verify that the exchange timelines were adhered to.
While the IRS does not specify requirements for QI qualifications and experience, it does indicate what entities or individuals may not serve in this capacity. The QI can't be the investor, be related to the investor (except by marriage), or be an employee or colleague. In fact, the QI may not have a direct financial connection to the exchanger, which means that your attorney, accountant, broker, and other agents are ineligible.
Most exchangers will engage the services of a professional QI or a company that provides the service. Fees vary, and investors should carefully review the fee structure, the method of safeguarding the funds, and the QI’s experience and history.
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.
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.