Who Can Be a Qualified Intermediary for a 1031 Exchange?

A 1031 exchange, also known as a like-kind exchange, allows real estate investors to defer capital gains taxes when selling an investment property and reinvesting the proceeds into a similar one. This tax deferral mechanism, outlined in Internal Revenue Code (IRC) Section 1031, is a valuable tool for continued real estate investment. A Qualified Intermediary (QI) plays an essential role in facilitating this process. Without a QI, the transaction would not meet IRS requirements for tax deferral.

Understanding the Qualified Intermediary Role

A Qualified Intermediary is an independent third party essential for a compliant 1031 exchange. Their involvement ensures the taxpayer avoids “constructive receipt” of the proceeds from the sale of their relinquished property. Constructive receipt means having direct access or control over the exchange funds, which would make the entire transaction taxable. The QI acts as a buffer, holding these funds and managing the exchange process under safe harbor provisions. The QI facilitates the sale of the relinquished property and the purchase of the replacement property, creating a structured exchange.

Qualifications and Restrictions for a Qualified Intermediary

The Internal Revenue Service outlines specific rules regarding who cannot serve as a Qualified Intermediary to ensure the independence of the exchange. A “disqualified person” is prohibited from acting as a QI, meaning individuals who have acted as an agent of the taxpayer within a two-year period prior to the transfer of the relinquished property. This includes an attorney, accountant, investment banker or broker, real estate agent, or employee of the taxpayer.

Entities related to the taxpayer are also considered disqualified. This relationship is defined by Internal Revenue Code Sections 267 or 707, which include family members and certain business entities where the taxpayer holds more than a 50% ownership interest. These restrictions prevent conflicts of interest and ensure the QI’s neutrality in the transaction.

Key Responsibilities of a Qualified Intermediary

A Qualified Intermediary undertakes several specific duties throughout the 1031 exchange process to ensure compliance with IRS regulations. The QI prepares the necessary exchange documents, including the exchange agreement, which formally outlines the terms of the exchange and the QI’s role. This documentation is essential for the transaction to be recognized as a valid exchange for tax purposes.

The QI holds the exchange funds in a segregated account, preventing the taxpayer from having actual or constructive receipt of the proceeds. QIs also coordinate with closing agents for both the relinquished and replacement properties, ensuring all financial transfers and title assignments align with the exchange requirements. The QI monitors and enforces adherence to the exchange timelines: the 45-day identification period for potential replacement properties and the 180-day exchange period to complete the acquisition.

Choosing a Qualified Intermediary

Selecting a Qualified Intermediary requires careful due diligence to safeguard exchange funds and ensure a successful transaction. Investors should assess the QI’s experience, looking for a track record of numerous completed exchanges and years in the business. Professional affiliations, such as membership in the Federation of Exchange Accommodators (FEA), can indicate a commitment to industry standards and ongoing education.

Financial security measures are a primary consideration. It is important to confirm that the QI holds exchange funds in segregated accounts, preferably in qualified escrow or trust accounts, rather than commingled with other funds. Inquiry should also be made about the QI’s fidelity bond coverage and errors and omissions insurance, which provide protection against theft or mistakes. Asking detailed questions about their processes, fund management, and contingency plans can help determine a QI’s competence and reliability.