A 1031 intermediary is engaged to accommodate a 1031 tax deferred exchange for taxpayers of all means when selling and replacing real and personal property. Also known as a qualified intermediary or exchange facilitator, the 1031 intermediary is one of four safe harbors the Internal Revenue Service instituted in 1991 whose outcome determines whether the taxpayer is in constructive receipt of money or other property for purposes of the Internal Revenue Code (IRC) Section 1031. The use of one or multiple safe harbors satisfies the g(6) limitations of the Code that the taxpayer is not to “actually or constructively receive exchange funds or to have an agency relationship with an exchange facilitator solely for purposes of IRC Section 1031.”
Safe Harbor No. 3 Qualified Intermediaries
Almost anyone can act as a 1031 intermediary with the exception of what is known as a disqualified person who is considered a related party to or an agent of the taxpayer. IRC Section 267(b) or 707(b) provides thirteen definitions of a related party including:
- Family members including siblings, spouse, ascending and descending blood lines
- An individual owning more than 50 percent of an entity
- Two corporations of the same control group
- Grantor and a fiduciary of the same trust
- An estate executor and beneficiaries
An agent is defined in the Regulations as the “taxpayer’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the two-year period ending on the date of the transfer of the first of the relinquished properties.” There are exceptions, including the performance of services that are “routine financial, title insurance, escrow or trust services for the taxpayer by a financial institution, title insurance company or escrow company.” Attorneys whose previous service has been closings only are eligible to be a 1031 intermediary. If the attorney’s firm has provided services other than closing or 1031 intermediary, then the firm and attorneys are considered disqualified persons.
1031 Intermediary Role
The first of two primary responsibilities of the 1031 intermediary is to prepare 1031 documentation in accordance with the 1031 Code for review and signature by the taxpayer prior to or on the day the property whose closing is completed. Their second responsibility is to hold the exchange proceeds for the benefit of the taxpayer in a manner to preserve the principal and liquidity. Qualified Escrow Agreements are often used requiring dual signatures for disbursements, one from the taxpayer and the other from the 1031 intermediary. Often the 1031 intermediary distinguishes their firm by having a Certified Exchange Specialist (CES) on staff who has passed a board level exam and maintains twenty hours of continuing education every two years.
A third responsibility is to provide the taxpayer with input when initially considering a 1031 exchange and throughout the exchange period, including how to navigate the same taxpayer requirement. The 1031 intermediary will typically provide guidance concerning the 45th and 180th calendar day and the three property and 200 percent identification rules. Once the exchange is completed, the 1031 intermediary may provide an exchange summary of the signed primary exchange documents supporting the 1031 exchange and assist in the preparation of the 8824 Form used to report the 1031 exchange to the IRS along with the taxpayer’s annual federal return.
1031 Intermediary State Laws
Eight states have legislated rules for the 1031 intermediary to protect their residents from malicious behavior. Failure for the 1031 intermediary to follow could result in civil and criminal charges. Currently those states include Washington, Oregon, California, Nevada, Idaho, Colorado, Virginia and Maine. The 1031 intermediary industry is not regulated. The Internal Revenue Service and Federal Trade Commission determined that the industry does a good job of policing itself and have declined to regulate. The Federation of Exchange Accommodators provides continuing education, the CES designation and Ethics Policy for its members.
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