Choosing a 1031 Qualified Intermediary: The Key to a Valid Exchange
If you’re an investor thinking about making a 1031 exchange in order to defer capital gains taxes, there are a few key rules and restrictions you need to keep in mind. When it comes to like-kind exchanges, the most critical and fundamental rule outlined in Section 1031 dictates that you cannot have control of the money from your sale as it is used to buy a new investment property.
To remain compliant, you must sell your current property and transfer all funds through a mandatory third-party 1031 qualified intermediary (QI). If you do not follow this process, what’s known as constructive receipt will occur. This essentially means that if you touch the money from the sale, it will no longer qualify as a 1031 exchange—or be eligible for tax deferral.
A QI is a critical partner in the transaction, as selecting the wrong fit can lead to lost funds or a disallowed exchange by the IRS. You can count on CapFree Xchange to help you navigate 1031 technicalities and qualified intermediary requirements with ease, making the process simple, safe, and accessible. Learn how to find the right QI for your exchange and get one step closer to creating passive income with a new investment property.
What Is a Qualified Intermediary and Why Is One Required?
Sometimes called an accommodator or facilitator, a 1031 qualified intermediary essentially acts as a middleman throughout the 1031 exchange. They serve an essential role in helping retain the tax-deferred status of the exchange—and the integrity of the purchase.
To start, the 1031 exchange facilitator will enter into a written exchange agreement with you, the investor. Then, the sale of the relinquished property is assigned to the QI and the property will go to the buyer, with the QI holding onto the proceeds. To fully complete the exchange, the QI is then assigned the purchase of the replacement property. They will use the funds from the sale to finish the transaction, eventually transferring the title to the investor.
Hiring an exchange accommodator ensures the transaction follows IRS guidelines. It also eliminates the chance of constructive receipt and allows this move to be strictly viewed as an exchange—instead of a sale and subsequent purchase.
1031 Disqualified Persons: Who Is Barred from Facilitating Your Exchange?
While it is important to know about qualified intermediary requirements and how to choose a 1031 exchange facilitator, it is perhaps equally important to know who is not allowed to be your QI. There are several rules regarding 1031 qualified intermediary eligibility, with a list of disqualified persons for 1031 exchanges to keep in mind.
As the investor and taxpayer, your QI cannot be an “agent” of yours at the time of the transaction or within the last two years. This means they can’t be:
- Your real estate agent
- Your attorney
- Your accountant
- Your employee
Your QI also cannot be someone who has an existing relationship with you, including:
- You
- Your spouse
- Any family member
While there are a few exceptions when it comes to disqualified persons for a 1031, you’ll want to act carefully to avoid jeopardizing your exchange. Always remember, an exchange accommodator must be a neutral, independent third party and a true middleman to ensure the validity of your 1031 exchange.
How to Select a Qualified Intermediary: Security and Due Diligence
The QI industry is largely unregulated by the federal government, but some states have implemented their own exchange accommodator guidelines. Here, the onus truly falls on the investor. Practice due diligence when it comes to understanding qualified intermediary requirements, keeping yourself and your investment protected in the process.
When looking for the right 1031 qualified intermediary for you, consider the following:
- Fund Security: This is a big one. You’ll want your QI to hold your funds in a segregated or escrow account, where your money is separate, instead of a commingled account, where your money is mixed with the funds of others. QIs sometimes hold exchange funds in these commingled accounts in order to generate higher revenue and interest, securing themselves greater earnings. However, you’ll want to make sure they truly have your investment (and best interest) at heart.
- Insurance and Bonding: Ask if your QI is equipped with Errors & Omissions (E&O) insurance to protect you and if they carry a fidelity bond to protect against fraud and theft.
- Experience: While the descriptor is in the name, you’ll want to make sure your QI is indeed qualified and up to the task. You should ask your potential QI how many years of experience they have and how many exchanges they’ve completed in the past. It’s also advised to check if they have Certified Exchange Specialists (CES®) on staff who agree to follow a code of ethics dictated by the Federation of Exchange Accommodators (FEA).
Plus, don’t forget to ask about qualified intermediary fees upfront to avoid any surprises during the process and make sure you have a solid understanding of what to expect.
Qualified Intermediary vs. Tax Advisor vs. Real Estate Agent
If you’re a bit confused about the various roles involved in a 1031 exchange, that’s totally understandable and you’re not alone. It can be a complicated process and there are a few professionals involved in the deal. Take a look at this handy list to see who is doing what—and when.
- The QI: Handles the exchange structure and legal documentation, holds the 1031 exchange funds during the course of the transaction, and ensures compliance throughout.
- The Certified Public Accountant (CPA)/Tax Advisor: Calculates cost basis, helps you understand tax rules and liability, and advises on financial strategy, making sure the exchange is properly structured for tax deferral.
- The Real Estate Agent: Markets the relinquished property and helps find a replacement investment property, typically negotiating the sale of both.
- The Title/Escrow Company: Handles the closing of the property, coordinates timelines, and passes sale proceeds directly to the QI—helping avoid constructive receipt.
Ensuring a Successful Deferral With CapFree Xchange
A 1031 qualified intermediary is more than a facilitator—they’re the key to unlocking 1031 tax benefits. And hiring one is critical to the success of your investment strategy.
Don’t put your capital gains at risk. Ensure you have the right team in place to handle strict 1031 exchange requirements. CapFree Xchange is here to act as a 1031 exchange facilitator and so much more, helping you identify replacement properties with our high-quality single-family rentals, coordinating the exchange, and taking on landlord responsibilities so you can simply invest, relax, and enjoy. Browse our solutions to see how we make the 1031 exchange process easy and learn more about why you should invest with us.
Frequently Asked Questions About 1031 Exchange Qualified Intermediaries
When should I hire a QI?
You must officially hire a QI before the sale of the property closes. If you complete the close without one, you will no longer be eligible for a 1031 exchange tax deferral.
Is my money safe with a QI?
To keep your money protected, you’ll want to hire a large, institutional, or bonded 1031 qualified intermediary that holds funds in a segregated or escrow account.
Can I earn interest on my money while the QI holds it?
While you may be able to earn interest on your money while it is held by the QI, this really depends on your specific agreement and where the QI keeps the funds located. Some QIs share interest, but others keep it as a part of their unique fee structure. Confirm the specifics surrounding interest and qualified intermediary fees before signing an exchange agreement.
Disclaimer: The information provided herein is not intended to be, nor should it be construed as an offer to sell or a solicitation of any offer to buy any securities. This presentation has not been reviewed or approved by any regulatory authority and has been prepared without regard to the individual financial circumstances or objectives of persons who may receive it. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. CapFree Xchange, an approved distributor of the Appreciation Homes product and wholly owned subsidiary of Capview Holdings, encourages any person considering any action relating to real estate topics discussed herein to seek the advice of your financial, investment, tax and legal advisors.
