Who Takes Title In a 1031 Exchange?

In a typical 1031 exchange, an investor decides to sell a property and reinvest the proceeds. If the property has appreciated during the time the investor has owned it, they will be responsible for paying capital gains taxes on the increase in the fair market value. Assuming that the investor has held the asset for more than one year, the taxes will be assessed at the long-term capital gains rate, which is typically lower than the tax rate for ordinary income but can still be as much as 20 percent.

However, the taxpayer can defer the recognition of those capital gains by reinvesting the proceeds from the sale using a 1031 exchange instead of a traditional sales and purchase transaction. The term “1031 exchange” refers to the relevant section of the Internal Revenue Code, and the method is also sometimes called a “like-kind” exchange.

What are the rules around 1031 exchange transactions?

For a taxpayer to successfully complete a 1031 exchange and thereby defer payment of the capital gains taxes, they must follow the IRS rules carefully. For example, two of the regulations involve timelines and access to proceeds.

First, the deadlines for a 1031 exchange are relatively tight. Once the investor sells the target property (usually referred to as the relinquished asset), they must complete their purchase of replacement property within 180 days. Within those 180 days, they must formally identify potential replacement options in the first 45 days following the sale. Investors have three options for identifying replacement assets:

1. Identify up to three properties, any or all of which have a market value equal to or greater than the relinquished property.
2. Identify any number of properties, but the combined value of those identified may not exceed 200 percent of the relinquished property’s value.
3. Identify any number of properties with any combined value, but the investor must ultimately purchase a combination that reaches at least 95 percent of the value identified.

Second, it’s vital that the investor does not have access to the proceeds from the sale of the relinquished property during the 180 days before completing the replacement acquisition. For this reason, the investor uses a Qualified Intermediary (QI, also sometimes called an exchange accommodator) to manage the exchange, hold the proceeds in a separate account, and receive the formal identifications. While QIs are not regulated, the IRS stipulates that you may not engage as a QI anyone to whom you are related or who is a business associate or agent.

Does the Qualified Intermediary hold title to the property?

As noted, the QI plays a vital role in the successful execution of a 1031 exchange. Therefore, investors should carefully consider the qualifications and experience of the Intermediary they engage. However, in a typical 1031 exchange, the QI does not take title to either the relinquished or replacement properties. 

The investor holds the title.

In a straightforward (deferred) 1031 exchange, the investor sells the property they have targeted for disposition, and the new owner takes the title. Then, when the investor identifies the replacement property (or properties), the QI will direct the funds from the escrow account to the seller, and the investor executing the 1031 exchange will take over the title. 

In contrast, if the taxpayer completes a reverse 1031 exchange, the QI will assume the role of exchange accommodator titleholder and temporarily maintain the title to either the relinquished or replacement property.

The impetus for a reverse exchange is that the taxpayer discovers a property they want to purchase before they sell the property targeted for disposition. Since the investor may not own the relinquished and replacement assets simultaneously, the QI must hold one. Reverse exchanges are subject to the same rules and timelines as traditional exchanges but have the added complexity of requiring an interim titleholder.