1031 Exchange Fees

1031 exchange fees represent payment to a Qualified Intermediary (QI) to accommodate a 1031 tax deferred exchange. A 1031 exchange is a tax deferral strategy federal and state taxpayers utilize to postpone the payment of capital gains and recaptured depreciation taxes when selling and replacing real property held in a trade, business or for investment. Both foreign and resident individuals, trusts, partnerships and corporations use this section of the Internal Revenue Code (IRC) to defer gain on farms, timberland, apartments, shopping centers, single family rentals, and more. In 2012, the Joint Committee on Taxation estimates that $3.2 billion in taxes were deferred with $1.2 billion to be initiated by individuals.

1031 Exchange Process

In a 1031 exchange, the QI prepares documentation created in accordance with the IRC supporting the taxpayer’s intent to initiate a 1031 and holds the exchange proceeds, typically in a bank under the taxpayer’s tax identification number. The bank account may or may not earn interest.  FDIC insurance insures those proceeds of $250,000 or less. When the taxpayer is ready to acquire the replacement property, the QI initiates a wire out for the closing.

There are different types of 1031 exchanges including:

  • Forward
  • Reverse
  • Deferred improvement
  • Simultaneous
  • International

The QI is compensated by a fee and potentially interest earned on the escrow account. The 1031 exchange fee is dependent upon the type of exchange, complexity and the QI involvement to accommodate the exchange. International exchanges may require the set-up of an escrow account in a foreign country to avoid converting foreign currency to US dollars. It takes time and research to establish foreign escrow accounts.

1031 Industry

Currently, the 1031 exchange industry is not regulated. The Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 created the Bureau of Consumer Financial Protection within the Federal Reserve. The law requires the Bureau to conduct a study and propose legislation to protect consumers engaging QIs accommodating 1031 tax deferred exchanges. The proposed recommendations are to be completed one year after the law takes effect and implement regulations within two years of the Bureau’s report.

Eight states including Washington, Oregon, California, Idaho, Colorado, Nevada, Virginia and Maine have enacted laws to protect their constituents requiring that exchange funds are held in a qualified escrow account with dual signatures authorizing disbursements or that the 1031 intermediary maintain a fidelity bond of at least $1,000,000 and a minimum $250,000 error and omissions insurance policy. Each state has a variation of the law and respective criminal and civil penalties.

Disqualified Persons

A disqualified person cannot act as a 1031 intermediary or an Exchange Accommodator Titleholder in a reverse 1031 exchange. In general, a disqualified person is a person or entity that is related to the taxpayer or is the agent of the taxpayer at the time of the transaction. An agent includes:

  • Taxpayer’s employee
  • Attorney
  • Accountant
  • Investment banker
  • Real Estate agent or broker

Exceptions allow for those above who have provided 1031 accommodation, routine financial, title insurance, or trust services for the taxpayer by a financial institution, title insurance company, or escrow company not to be deemed disqualified. A firm and their associates who have provided additional services to the taxpayer are considered disqualified from acting as a 1031 intermediary.

An attorney and accountant may not act as the taxpayer’s 1031 intermediary if the attorney or accountant has performed legal or accounting services for the taxpayer within two years prior to the exchange.

Are you considering a 1031 exchange? Do want to understand when a 1031 exchange makes sense? Download a complimentary eBook answering that question by clicking here.