The 1031 exchange Qualified Intermediary (QI) was one of four safe harbors the 1031 Regulations created in 1991 for use in a 1031 exchange to fulfill the requirement that the taxpayer is not in actual or constructive receipt of exchange funds or property as part of a 1031 exchange. If it is determined that the taxpayer has or had access to the funds during the exchange, the 1031 exchange may very well be nullified and taxes deferred due. A QI under Safe Harbor Number 3 is not recognized as the taxpayer’s agent for purposes of the 1031 exchange.
QI Role
The QI holds the exchange funds in a safe, liquid, non-commingled account under the taxpayer’s tax identification number. The escrow account can be a qualified escrow account requiring dual signatures, a personal identification number known only between the taxpayer and bank, or have no procedures to authorize disbursements. A number of states may require the use of a qualified escrow account. Finally, the QI prepares exchange documentation in accordance with the 1031 Regulations supporting the taxpayer’s intent to initiate a 1031 exchange.
One requirement of the documentation is to clearly state in the exchange agreement the following (g)(6) limitations:
“In accordance with Regulation § 1.1031(k)-1(g)(6), in no event shall Exchangor receive, pledge, borrow or otherwise obtain the benefits of the Exchange Account, including earnings thereon, before the end of the Exchange period.”
The QI cannot be someone who is considered an agent of the taxpayer at the time of the exchange. Disqualified persons who cannot be the taxpayers QI include family members, related parties or “a person who has acted as the taxpayer’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the 2-year period ending on the date of the transfer of the first of the relinquished properties in a like-kind exchange.” There are exceptions, such as the attorney who has only provided title closing services and banks.
Forward 1031 Exchange
There are many different types of 1031 exchanges to fit the transaction requirements. In a forward exchange, the QI is assigned the Purchase and Sale Agreement rights but not the obligations. The property is conveyed from the taxpayer or exchangor to the buyer. The exchangor signs an exchange agreement establishing the intent to exchange the relinquished property that was held in a business or for investment for replacement property to be held in a business or for investment within 180 calendar days. The Buyer is asked to sign a Notice of Assignment.
Furthermore, the exchangor agrees to formally identify to the QI or title company, the potential replacement properties by the 45th calendar day post relinquished property closing. The net proceeds of the sale are wired to an escrow account and held until needed for the earnest money deposit or for the replacement property purchase.
At the replacement property closing, the QI is assigned the Purchase and Sale Agreement rights and instructs the title company or real estate attorney to direct deed the property from the exchangor to the seller. The seller is asked to sign a Notice of Assignment.
Assignment Language
The QI will suggest including assignment language in the Purchase and Sale Agreements, requesting the buyer or seller to approve the option for the taxpayer to initiate a 1031 exchange. Taxpayer agrees to hold buyer/seller harmless from any and all claims, liabilities and costs of such an exchange. Many real estate contracts have the exchange option embedded into the contract as shown in the linked Florida Realtors contract, page 10, line 524. The assignment language is not required when selling, but is when buying, given assignment of the Purchase and Sale Agreement requires the approval of the Seller.
Throughout the exchange, the QI provides the exchangor with responses to questions related directly to the 1031 exchange and refrains from offering advice on accounting and/or legal matters, unless the QI is licensed or within scope of their services to provide such counsel.
Download a complimentary document summarizing what four questions the more experienced exchangors ask when vetting QIs.
