Qualified Intermediary Requirements: 1031 Exchange Series Part Five

If you’ve been following along with our seven-part series on 1031 Exchange basics, you know that we’ve already covered the first three of the six basic requirements. Now, we are moving on to the fourth requirement, using a Qualified Intermediary. The IRS requires the process of a 1031 Exchange to be documented and managed by the Qualified Intermediary. In this article we will discuss the requirements for a Qualified Intermediary (QI). Both their role in the exchange process and what to look for your QI.

1031 Exchanges Require a Qualified Intermediary

The IRS has a strict set of rules and time limits that you must stick to in order to qualify for a 1031 Exchange. Using a Qualified Intermediary to document all the transactions of your exchange and hold your proceeds is part of those rules. The IRS code states that an unrelated third party must document and manage just the 1031 Exchange part of the transaction. During the exchange process, you will use the services of your usual and familiar real estate professionals. This may include a real estate attorney, a title company, an accountant for tax reporting, and probably several real estate agents. A Qualified Intermediary is simply another professional that is added during a 1031 Exchange. In addition to their mandated role, a good QI will also act as your guide through the process.

Something important to note here is that the Qualified Intermediary MUST be involved before the closing of the sale of your investment property. A 1031 Exchange starts with the sale of a piece of investment real estate and ends with the purchase of replacement property. But this only works if your Qualified Intermediary is in place prior to the sale.

 

Who Can Be Your Qualified Intermediary?

The Qualified Intermediary is an unrelated third party. While we have mentioned a “third party” before, it’s important to emphasize that the Qualified Intermediary must truly be a third party. It cannot be your attorney, real estate agent, husband, or wife, etc. It has to be a completely unrelated party where all they do for you is document and manage your 1031 Exchange.

While the statue isn’t completely clear on what “qualified” is, it is crystal clear on what disqualifies someone from this role. That is: if there’s an agency relationship, a business relationship or a family relationship, the person or entity would be disqualified. This essentially means that as long as you haven’t purchased used tires from the used tire shop down the road, they could technically act as the Qualified Intermediary. However, that’s clearly not in your best interest. To understand why, let’s take a look at exactly what the Qualified Intermediary does.

What does the Qualified Intermediary Do?

The Qualified Intermediary will work alongside you and the rest of your regular professionals to document the entire 1031 Exchange and hold the proceeds from your sale. At a minimum, this includes:

  • Creating an exchange agreement (between QI and the investor)
  • Providing the assignment of contract rights (signed by the investor and enacted by the title company)
  • Giving notification (all parties to the transaction have to be notified – no standard of when)
  • Receiving and maintaining sale proceeds during the transition into the new investment/until the end of the exchange

Let’s take a closer look at these official aspects of the QI’s role.

EXCHANGE AGREEMENT

There will need to be an exchange agreement between you and your Qualified Intermediary that lays out all of the requirements we discuss in this article series. This agreement will specify what your role is going to be, what you’re going to have to do to finish the exchange, and what the Qualified Intermediary is going to do for you. This exchange agreement will be your contract with them.

ASSIGNMENT OF RIGHTS

As part of the process of using the Qualified Intermediary, there must be an assignment of rights. This is where you assign your rights to the sell the property to your Qualified Intermediary. Many states and jurisdictions already have real estate contracts that have check the boxes or default cooperation addendums for a 1031 Exchange. If that is not the case with your contract, we recommend you simply make your contracts assignable if possible. Regardless, this assignability and the exchange documents prepared by your QI allow the title company to direct deed the properties from the exchanger to the buyer and from the seller to the exchanger.

Note that your QI should never take title to either the relinquished or replacement properties. The QI is the assignee only on the settlement statement. This is an aspect of the assignment of rights that should be discussed in your Qualified Intermediary selection process (see more below).

NOTIFICATION

The statute does not specify how or when the parties to the exchange must be notified, only that it is required. Some exchangers have experienced more aggressive bargaining situations when the seller realizes a 1031 Exchange is in process. As a result, most QIs opt to provide this required notice as part of the closing process.

RECEIPT AND MAINTENANCE OF PROCEEDS

For an exchange to be valid, the investor may not have actual or constructive receipt of the proceeds from the sale of their relinquished property. Remember how we said before that you must have the Qualified Intermediary before you close the sale of your investment property? Part of the reason why is that after the closing of the sale, your proceeds must go into an exchange account with the Qualified Intermediary. The IRS considers funds in escrow with the title company constructive receipt by the seller, so the funds must be transferred to the QI. Then, when you purchase your replacement property, the funds will be transferred by the QI directly to the title company for closing.

Finding and Hiring the Right Qualified Intermediary

As your QI has to be an unrelated third party and will be holding significant cash on your behalf, we recommend you look for someone that meets these five criteria:

  1. Uses dual signatory segregated, qualified escrow accounts for your exchange funds (at no charge).
  2. Guarantees their exchange documentation.
  3. Provides support and documentation in the case of an IRS audit (at no charge).
  4. Is easily accessible to answer questions (at no charge).
  5. Has extensive, verifiable experience and a solid reputation.

While the exchange fee charged is a consideration, there is a range and a variety of potential additional charges among QIs who meet the above criteria. We recommend you check out our previous article on how much an exchange should cost to see what you should be paying and what your fee covers.

Don’t miss the next part of our series on the 1031 Exchange basics, when we’ll be talking about all of the necessary title requirements.

 

Originally posted on The Bigger Pockets Member Blog.

180-Day Rule: 1031 Exchange Series Part Four

So far in our seven-part series on 1031 exchange basics, we have discussed the six basic requirementsproperty being held for investment, and the 45-day identification rule. In the fourth part of our series, we are going to discuss more in depth the third requirement for a 1031 exchange which is the 180-day rule. If you’re curious about what this rule is and the timing requirements behind it, continue reading on to learn more.

The 180-Day Rule

As we have discussed in previous articles, there are two critical timing requirements when completing a 1031 exchange. This first is the 45-day identification rule which we discussed in part three of this series. The second is the topic we are discussing now, the 180-day rule. The 180-day exchange period runs concurrently with the 45-day identification rule. Therefore, if you haven’t read that part yet, we highly recommend it. However, here is a brief summary:

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Day one of the 45-day identification period starts on the day of your closing. You have 45 calendar days from the day of your closing to identify the replacement properties and take title to it OR produce a written list of the replacement properties that you’re going to use.

Similarly, the 180-day rule also starts on the day that you close your property. As we also mentioned, it runs concurrently with the 45-day identification rule. What this means is you have a total of 180 days to complete the entire 1031 Exchange transaction. While you may have 45 days to identify properties, you have a total of 180 days to close on the new property and accept the title to it. It’s important to note that the property you choose must be one of the properties from your 45-day list.

You Must Choose a Property from Your 45-Day List

One of the requirements of the 180-day rule is that you must choose a property from the45-day list you have turned in. This is a Federal IRS rule and there are no exceptions and no extensions. 180 days to complete an exchange sounds like a long time. It is the 45-day period is where most people get lost or fall behind. It is imperative you start looking for replacement properties as soon as possible and make a list of potential properties. In the end, when the 45 days are up, you are left to choose from that list and that list only. You will then have to close on one of those properties within the 180-day window.

You May Have Less than 180 Days

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If you’ve ever read over any federal laws, you know that they are very complicated and nuanced. Unfortunately, there is no exception here. With the 180-day rule, you actually have the lesser of 180-days or to the date of your next tax filing. The reason for this is the IRS wants your 1031 Exchange wrapped up and completed before you file your taxes. Therefore, it has to be reported on your next tax return.

For example, as everyone knows Tax Day is April 15th. If you sold your relinquished property on December 15th, you would have until April 15th to completely wrap and finish your 1031 Exchange by purchasing your replacement property or properties. This could be significantly less time than the allowable 180 days. You can easily avoid this by filing for an extension on your taxes. But, it’s a very important aspect to keep in mind. If you know you aren’t going to be able to complete your 1031 Exchange before taxes are due, go ahead and file for an extension.

Timing is Everything with the 180-Day Rule

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In the last two articles, we’ve discussed a lot about timing. The reason for this is because timing is everything in a 1031 Exchange. Properties must be identified within 45 days and you then have 180 days to close on one or more of those properties, and only those properties. However, keep in mind that you may actually have less than 180 days if you are due to file your taxes before then. If that is the case, you may want to request an extension on your taxes so you have time to finish your 1031 Exchange.

This article was originally posted at https://www.biggerpockets.com/member-blogs/12255/91039-180-day-rule-1031-exchange-series-part-four.