What a qualified intermediary does

The safe harbor

A deferred exchange, where the sale of the relinquished property and the purchase of the replacement property do not happen simultaneously, creates a problem: between the two closings, the exchanger's sale proceeds have to go somewhere. If the exchanger has the right to receive or control those funds, even briefly, the exchanger is treated as having constructive receipt of the money, and the exchange fails.

Treas. Reg. §1.1031(k)-1(g)(4) provides the safe harbor that solves this. Using a qualified intermediary under a written exchange agreement, entered into before the relinquished property transfers, prevents the exchanger from being treated as having actual or constructive receipt of the funds, provided the agreement expressly limits the exchanger's rights to receive, pledge, borrow or otherwise obtain the benefit of the exchange funds, consistent with §1.1031(k)-1(g)(6).

Under the agreement, the qualified intermediary acquires the relinquished property from the exchanger and transfers it to the buyer, and separately acquires the replacement property from the seller and transfers it to the exchanger. In practice this is almost always accomplished by assignment: the exchanger assigns its rights under the sale contract and the purchase contract to the qualified intermediary, with written notice of the assignment given to the other parties on or before the relevant transfer. Direct deeding is permitted, meaning title can pass directly from the seller to the exchanger and from the exchanger to the buyer without ever routing through the qualified intermediary, so long as the assignment and notice requirements under §1.1031(k)-1(g)(4)(iv) and (v) are met. The qualified intermediary is not treated as the exchanger's agent for purposes of section 1031, even though it is acting on the exchanger's behalf in the transaction.

The (g)(6) restrictions

The safe harbor depends on the exchanger's rights to the exchange funds being genuinely limited for the life of the exchange. Under §1.1031(k)-1(g)(6), the exchange agreement must expressly provide that the exchanger has no rights to receive, pledge, borrow against or otherwise obtain the benefit of the funds held by the qualified intermediary before the earlier of the end of the exchange period or the occurrence of certain specified events. Those events, described in §1.1031(k)-1(g)(6)(ii) and (iii), are: the end of the identification period, if the exchanger has identified no replacement property; the exchanger's receipt of all of the replacement property it is entitled to receive; and, after the end of the identification period, a material and substantial contingency that relates to the exchange, is provided for in writing, and is beyond the control of the exchanger and of any disqualified person (other than the seller of the replacement property). Outside of those circumstances, the exchanger has no access to the funds at all while the exchange is open, regardless of hardship or changed plans.

Who cannot serve as the QI

Treas. Reg. §1.1031(k)-1(k) defines the people and entities that are disqualified from acting as an exchanger's qualified intermediary. A disqualified person includes anyone who has acted as the exchanger's agent at any time within the two years before the relinquished property transfers. This category covers an employee of the exchanger, and anyone who has served the exchanger as an attorney, accountant, investment banker or broker, or real estate agent or broker, within that two-year window.

It also includes related parties. A person related to the exchanger under section 267(b) or section 707(b), with the ownership threshold in those sections reduced from more than 50 percent to more than 10 percent, is disqualified. This reaches family members and entities the exchanger or the exchanger's family controls to that degree. It also reaches persons related at that level to the exchanger's agent, such as a company owned by the exchanger's attorney.

The regulation carves out two exceptions. Routine financial, title insurance, escrow or trust services provided by a financial institution, title insurance company or escrow company are not counted when deciding whether that company was the exchanger's agent; a related party remains disqualified. And a person who has performed services for the exchanger with respect to section 1031 exchanges in the past, but not other services, is not disqualified on that basis alone. Outside those exceptions, the independence requirement is treated strictly: an account held by the exchanger's own attorney or accountant (if they are disqualified persons), or any account the exchanger can draw on, does not satisfy the safe harbor, regardless of the professional's good intentions.

What a QI does in practice

• Prepares the written exchange agreement and the assignment documents for the sale and purchase contracts.
• Takes assignment of the exchanger's rights under those contracts and gives the required notice to the other parties.
• Holds the sale proceeds between the two closings, on the terms set out in the exchange agreement.
• Receives the exchanger's written identification of replacement property and keeps a record of it.
• Coordinates closing instructions with the title or escrow company handling each transaction.
• Wires the exchange funds to the replacement property closing and disburses any remaining funds at the end of the exchange.
• Provides a final accounting of the exchange once it is complete.

What a QI does not do

A qualified intermediary handles the mechanics of the exchange: the agreements, the funds and the paperwork. It does not give tax advice or legal advice, does not give investment advice about which replacement property to buy, and does not determine whether a particular exchanger's transaction actually qualifies for deferral under section 1031. Those questions belong to the exchanger's own CPA and attorney. onezero3one does not give tax or legal advice.

How the industry is regulated

There is no federal license or federal regulatory body for qualified intermediaries. The regulations define who can act as a qualified intermediary, but no federal agency checks that in advance. Several states have adopted their own licensing or bonding requirements for exchange facilitators, with requirements that vary by state. Because there is no uniform national standard, the questions an exchanger asks before engaging a QI matter more than any title the QI uses.

What to ask a QI

Before signing an exchange agreement, an exchanger should understand how the funds will be held, including whether the account is segregated to that exchange rather than commingled with other clients' funds; what the written exchange agreement says about the exchanger's rights to the funds during the exchange period; and what verification procedures are in place before funds are wired out, given how often exchange proceeds are targeted by wire fraud. A qualified intermediary should be able to answer these questions clearly and put the agreement in writing before any funds move.

Sources

• Treas. Reg. §1.1031(k)-1(g)(4) (qualified intermediary safe harbor; assignment and direct deeding under (g)(4)(iv) and (v)).
• Treas. Reg. §1.1031(k)-1(g)(6) (restrictions on the exchanger's rights to the exchange funds).
• Treas. Reg. §1.1031(k)-1(k) (disqualified persons).
• Internal Revenue Code §267(b) and §707(b) (related-party ownership tests referenced in the disqualified-person definition).