How to Find a Qualified Intermediary for 1031 Exchanges
Many investors find themselves in a situation where they have plenty of equity in their property and want to trade up or buy additional properties. Fortunately, with 1031 exchanges, investors can sell properties with unlimited gains, deferring their tax liability by exchanging that property for a like-kind property within a defined time limit. The caveat to this is that investors need to find a qualified intermediary to help facilitate the process.
So, what is a 1031 exchange qualified intermediary, and how do you find one? This guide will provide you with the basics regarding qualified intermediaries, what they are, what they do, how to find them and what questions to ask before choosing one for a 1031 exchange.
What Is a Qualified Intermediary?
The fundamental definition of a 1031 exchange, also called a like-kind exchange, is a swap of two investment properties. In classic transactions, these would occur between two people who each want the other's property. However, the odds of finding someone with a desirable property who also wants to assume ownership of yours is very low. As a result, most people have to perform what is called a delayed exchange, also known as a three-party or Starker exchange.
In a delayed 1031 exchange, the property seller must identify a like-kind replacement property within 45 days of selling their relinquished property and purchase it within 180 days. During that time, however, the seller cannot hold onto the funds from their sale. Instead, the IRS requires the presence of a qualified intermediary.
So, what's a qualified intermediary in a 1031 tax-deferred exchange? Also known as a QI, exchange accommodator or exchange facilitator, a qualified intermediary is someone a property seller selects to oversee the 1031 exchange process and its funds. Delayed 1031 exchanges cannot proceed without the presence of a qualified intermediary, so it is crucial to choose one and get them involved in the process as soon as you've decided to pursue an exchange.
What do Qualified Intermediaries Do for 1031 Exchanges?
Qualified intermediaries hold a pivotal role in facilitating 1031 exchanges. Typically, they perform a range of essential tasks, including:
- Preparing the legal agreements needed to structure the 1031 exchange.
- Preparing documentation regarding the relinquished and replacement properties.
- Providing instructions and documents regarding the exchange for the escrow or title company.
- Holding the funds from the sale of the surrendered property in an escrow account while the seller identifies and purchases a replacement property.
- Preventing the seller from using the funds from the sale of the vacated property.
- Receiving and holding information regarding any specified properties.
- Transferring the funds for the replacement property's purchase upon the sale's finalization.
- Ensuring the exchange complies with all rules and regulations set forth by the IRS.
- Submitting complete documentation of the transaction to the seller for their records.
- Sending a 1099 form to the seller and the IRS for any interest earned during the process.
In short, the qualified intermediary is the primary individual responsible for facilitating the exchange and ensuring it proceeds correctly. They set up the agreement, manage the funds so the seller does not have access to them and transfer the funds for the new property's purchase. Moreover, they do it all while following 1031 rules and related IRS regulations to the letter.
Who Can Be a Qualified Intermediary?
Due to the level of responsibility falling on the qualified intermediary, investors must select a reliable, trustworthy person to fulfill this role. You may reasonably question who can be a qualified intermediary for a 1031 exchange. The rules here are relatively lax.
Under federal regulations for 1031 exchanges, practically anyone can become a qualified intermediary. There's no current federal regulation governing the industry as a whole. However, some states have legislation overseeing necessary limits and restrictions, including licensure and standards for insurance coverage and escrow account ownership. Be sure to review any state laws regarding qualified intermediaries before beginning your search for one, so you know what to expect.
Outside this top-level regulation, there are further limitations on who can act as a qualified intermediary for a specific exchange. Under Treasury Regulations section 1.1031(k)-1(g)(4), a qualified intermediary cannot be the investor, a relative of the investor or a "disqualified person." This section defines a disqualified person as anyone who has acted as an agent for the investor within the last two years before the relinquished property's sale. Some examples of agents who would count as disqualified persons include, but are not limited to:
- The investor's employee
- An attorney
- An accountant
- An investment banker or broker
- A real estate broker or agent
- These rules exist to ensure an independent relationship between the investor and their qualified intermediary.
Choosing a Qualified Intermediary for a 1031 Exchange
There are hundreds of qualified intermediaries and QI companies in the United States to select from. Some basic methods for finding potential qualified intermediaries for your 1031 exchange include:
- Asking your local escrow officer for recommendations.
- Speaking to fellow investors in your network for references.
- Using national directories for QIs registered with regulatory groups, such as the Federation of Exchange Accommodators.
While these methods can give you plenty of options for a qualified intermediary, the most significant question isn't how to find a qualified intermediary, but rather how to pick a qualified intermediary from your available choices.
What to Look for in a Qualified Intermediary
Between the amount of money involved and the complicated regulations, there's a lot at stake in a 1031 exchange. For this reason, it's vital to choose the right qualified intermediary. Make a short list of a few options to choose from, then work with your tax adviser and other trusted financial advisers to identify the most qualified intermediary for your 1031 exchange. Below are some of the main points you should consider when looking into your options.
1. Experience Level
The first thing you will want to know about a potentially qualified intermediary is their experience and track record. Many QIs have extensive knowledge about 1031 exchanges and backgrounds in related fields, so it is smart to get a feel for what they know and how well they have performed in the past. Here are some ideas of topics to cover.
Experience: Ask baseline questions to determine how long they have been doing 1031 exchanges and how many they have done. Some example questions include: "How long have you worked with 1031 exchanges?" "What was your most challenging exchange?" "How many 1031 exchanges have you done?" "Why do investors choose you over other intermediaries?" and "What is the most memorable mistake you've ever seen?" The longer the QI has been in business, the better.
Full- or part-time status: Some QIs do exchanges as a part-time side job alongside their usual work responsibilities. That may suffice for small, straightforward exchanges, but for more complicated property swaps, you will want someone who dedicates their time to executing these transactions and whose livelihood is on the line if something goes wrong.
Complex exchanges: Even if you are doing a relatively simple exchange, it's smart to understand how comprehensive your qualified intermediary's experience is. Ask them about the most complex exchanges, construction and reverse exchanges and whether they have done them in the past. Even if you are not performing this type of property swap, having a qualified intermediary with experience in complex transactions means that you can trust their thorough knowledge of 1031 regulations.
Licensure and designation: Some states require licensure for qualified intermediaries, but it is smart to work with a qualified intermediary who has gone through the necessary steps of earning licensure or certification, even if they don't strictly need it.
When you're interviewing qualified intermediaries, ask the average dollar amount for the exchanges they have performed in the last few years. Ideally, you should select a qualified intermediary with experience handling transactions around the same size as what you want to perform.
2. Insurance, Bonds and Funds Management
Another crucial consideration is the financial aspect. Ask potential qualified intermediaries about the following factors.
Holds fidelity bonds: All QIs should hold fidelity bonds of at least $1 million. These are insurance that protects businesses from theft or dishonest behavior, such as if an employee of the QI's company steals from your account while it is in escrow.
Errors and omissions coverage: All qualified intermediaries must have errors and omissions coverage, which protects you if a QI's paperwork mistake causes your exchange to fail. This coverage allows you to collect damages from the insurance company, rather than the qualified intermediary.
Fund separation: Verify that your funds will not get commingled with funds from other clients. While this is uncommon, it is a valid question to ask, as this prevents your money from seizure if the QI declares bankruptcy during the exchange process. All qualified intermediaries should hold funds in separate trust or escrow accounts in FDIC-insured banks.
Again, as rules and requirements vary from state to state, not all qualified intermediaries will maintain the coverage and procedures listed above. However, regardless of state regulations, it's smart to work with a qualified intermediary who meets these basic standards. Hiring a qualified intermediary who isn't bonded or insured leaves you open to the risk of major losses in the event of theft or clerical errors.
3. Customer Service
Responsiveness and quality customer service is another thing you will want to assess with your potential qualified intermediaries. You can judge this through various means.
Direct interactions: Take note of response times whenever you contact a qualified intermediary. You will want a QI who replies to requests relatively quickly and answers questions with thorough responses. If you are working over a long distance and can't meet face-to-face with a QI, it is especially vital to note their preferred contact methods and their average response time. It is also essential to discover how helpful they are and their willingness to consult with you — intermediaries who are eager to confer and provide instruction will be more beneficial to have on your side if you are performing your first 1031 exchange.
Reviews and references: If your qualified intermediary has industry experience, chances are that they have reviews and references available. Look for online reviews where possible, but you should also ask a potential qualified intermediary for customer references. Beware of qualified intermediaries who can't provide references or testimonials.
In this area, information from your network would be helpful. Ask network contacts about any interactions they have had with a qualified intermediary to add to your assessment.
4. Costs and Fees
Costs and fees are the final factors to consider when choosing a qualified intermediary. While pricing is always crucial, it is essential to find a qualified intermediary with the experience and coverage you need for your exchange.
For typical delayed exchanges, most qualified intermediaries charge around $700 to $1,100 per transaction. If you are doing a more complex exchange, however, prices will likely increase. Reverse exchanges, where a replacement property is purchased before an old property is sold, tend to be more expensive than a typical delayed exchange. Construction exchange prices run even higher, costing from $6,000 to $10,000 due to their complexity. These fees will increase depending on the property values, the number of parties and properties involved and other factors.
Before choosing a QI, request quotes from multiple qualified intermediaries to get a fair price estimate. This process is especially recommended if you are doing a more complex type of exchange. As with any service, avoid qualified intermediaries who quote you significantly lower than the average.
On top of the base prices, ask about fees for other services, such as wire transfers, title transfers and rush services. These will add up quickly, so it is crucial to understand them for the sake of preparation.
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Taking advantage of 1031 exchanges is an excellent way to manage investment wealth, and finding a knowledgeable, qualified intermediary is the best path to ensure success. Your qualified intermediary will play a significant role in your 1031 exchange, so it is paramount that you ask the right questions to find a fit for your needs.
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