A Qualified Intermediary plays an essential role in successfully executing any 1031 exchange. This professional has several critical responsibilities to ensure that the exchange complies with IRS regulations. Perhaps most importantly, the QI takes possession of the proceeds from the sale of the identified property when it is sold and maintains those funds separately from the investor until they are used to complete the exchange into replacement property (or properties).
The term 1031 exchange or "like-kind exchange" refers to Section 1031 of the Internal Revenue Code, relating to the deferral of capital gains taxes. If an investor sells an investment property, they may defer the payment of capital gains taxes by reinvesting the proceeds into a like-kind replacement property of equal or greater value. The IRS has been generous with the interpretation of "like-kind," and almost any investment real estate is qualified. But the process must be followed stringently for the exchange to be eligible, and that is where the use of the Qualified Intermediary becomes crucial. The QI must coordinate these vital tasks:
The IRS refers to Qualified Intermediaries, but other sources often use Exchange Accommodators or Facilitators. Even the industry association, the Federation of Exchange Accommodators, uses the terms interchangeably. The FEA offers a certificate program for exchange specialists, but there are no legal qualifications. However, the IRS has listed who a QI may not be:
While the investor's accountant or real estate broker may not serve as their QI for handling the 1031 exchange, these experts may be excellent referral sources. In addition, there are QIs affiliated with banks and other financial institutions and others who work independently. The investor should thoroughly investigate the qualifications of the person or firm they choose and consider these questions:
Choosing a well-qualified and experienced intermediary is crucial to the exchange's success. The IRS is strict about the timelines for identifying replacement properties and the execution of the transactions involved in the exchange. Failure by the QI can result in disqualification of the 1031, resulting in an unwanted tax bill.