Selling investment real estate can create a tax burden. A 1031 exchange qualified intermediary (QI) helps defer those capital gains taxes. This post explains using a 1031 Real Estate Exchange Qualified Intermediary (QI) in a 1031 exchange, from understanding their role to choosing the right one.
Table of Contents:
- What is a 1031 Exchange Qualified Intermediary?
- Steps a QI Takes in a 1031 Exchange
- Who Can Be a QI?
- Choosing a 1031 Real Estate Exchange Qualified Intermediary: What to Look For and Avoid
- National vs. Independent QIs: Weighing Your Options
- My Two Cents on 1031 Exchanges
- Conclusion
What is a 1031 Exchange Qualified Intermediary?
A 1031 exchange, based on IRC §1031 , allows swapping one investment property for another. This defers capital gains, depreciation recapture, and net investment income taxes – all the nasty taxes that can be generated when you sell your investment property.
A 1031 real estate exchange qualified intermediary is essential to this exchange process. They play referee, overseeing the exchange to keep everything by the book and in line with IRS regulations. This prevents you from directly handling the sale proceeds, which would disqualify the exchange transaction.
Steps a QI Takes in a 1031 Exchange
A QI’s role involves several key steps within a tax-deferred exchange. An exchange agreement is drawn up, with every term laid out in black and white.
This document is signed before the relinquished property sale. The QI receives the funds from the sale and holds them in escrow. You cannot directly access this money, as that triggers the taxes you want to avoid, according to IRS guidelines .
After you identify a replacement property , the QI buys it on your behalf with the funds they hold in escrow from your property sale. The replacement property must be “like-kind” ( IRS guidelines apply). They’ve probably picked up another property to add to their portfolio. The intent is important, not an exact match.
For example, you could exchange raw land for commercial property, or a commercial space for a residential rental property acquired. Finally, the QI transfers the title to you. That’s a wrap – we’ve completed the process from start to finish.
Exchange documents are also part of their duties – they take care of getting all those papers in order. dotting every i and crossing every t is essential when dealing with the IRS.
Who Can Be a QI?
A QI cannot be you, your real estate agent, estate agent, attorney, accountant, taxpayer’s employee, or any agent within two years of the sale. These disqualified persons have connections too close to avoid “constructive receipt”.
This disqualifies the 1031 exchange under the 1031 code . You cannot touch the proceeds of the property exchange. An unrelated third party is necessary for a correct delayed exchange.
Choosing a 1031 Real Estate Exchange Qualified Intermediary: What to Look For and Avoid
Choosing the right QI is crucial. The Federation of Exchange Accommodators lists qualified intermediaries. Some are local; others belong to national organizations.
Expertise and Experience
Seek a QI with substantial 1031 exchange experience. They should know various exchange types: improvement exchanges, reverse exchanges, and delayed exchanges. Verify credentials and certifications in exchange work.
The QI should have experience with different exchange types, property sizes, and complexities, like triple net leases or fractional ownership deals. Ensure accessibility and proactive communication.
Insurance and Bonding
Ask potential qualified intermediaries about safeguards for exchange funds. Safety first: that’s the approach when it comes to client funds. They use accounts insured by the FDIC and qualified escrow accounts to prevent losses.
Don’t gamble with your business; get protected with significant bond amounts and targeted insurance like crime bonds and errors and omissions policies. If things go south, these safeguards have got your back. Avoid QIs without fidelity bonds or insurance.
Theft and mistakes happen. Don’t risk uncovered losses with escrow funds or paperwork errors. Consider protection against legal issues.
References
Investigate the QI’s prior exchanges. Request client referrals. Read reviews and public client data for the exchange industry.
National vs. Independent QIs: Weighing Your Options
Choosing between national and independent local QIs for your real property transaction involves distinct advantages and disadvantages.
National QI Firms
Pros:
- Wider network of affiliated title companies, potentially streamlining transactions and saving costs. Using a different title company than the buyer’s or seller’s preference could mean higher upfront costs and transaction complexities.
- Ramping up what we have will take a fresh influx of tools and tangible assets.
Cons:
- Potentially less personal focus on transactions.
Independent/Local QI
Pros:
- More personalized focus.
Cons:
- Potentially more expensive and slower processing due to limited systems or economies of scale. Large-scale 1031 exchanges open the door to more potential missteps.
My Two Cents on 1031 Exchanges
For 23 years, I’ve guided investors through the property exchange process, including QI selection and property identification notice considerations for potential replacement properties. Whether you’re new to 1031s or have numerous transactions under your belt, a specialized Exchange Advisor can cater to your needs.
Surround yourself with experts who’ve got the scoop on a wide range of properties – we’re talking beyond your run-of-the-mill triple net leases and generic institutional deals. Ideally, they’ll provide support that aligns with your goals and boasts a deep knowledge of premium real estate assets.
Most investors prefer passive ownership and portfolio diversification. Delaware Statutory Trusts (DSTs) offer lower investment minimums. DST debt financing avoids personal recourse. This allows participation even during challenging financial times, regardless of income, although professional investment advice is recommended. Seek quality providers with careful selection of intermediary services.
Consult with your tax advisor regarding tax consequences and tax benefits when selling relinquished property or purchasing replacement property with exchange proceeds within the identification period. Consider carefully tax liability related to the property acquired, non-like-kind property, taxable boot, property held for investment purposes, exchange expenses, like-kind replacement property received, and the potential for a taxable sale if not executed per Internal Revenue Code Section 1031 within a 180-day exchange.
Conclusion
A 1031 real estate exchange qualified intermediary is crucial for a successful tax-deferred exchange, helping you swap investment real property. They allow you to defer taxes when changing investments to like-kind property and adhering to state legislation if applicable.
A reliable advisor ensures efficiency, with an intermediary supporting you at each step. They peel back the curtain on what QI services can really do.