QI Expectations When Initiating a 1031 Exchange

1031 Exchange ExpectationsWhen a taxpayer engages a Qualified Intermediary (QI) or Certified Exchange Specialist® (CES) to accommodate their 1031 exchange tax deferral, they should know what to expect. This article provides an overview or roadmap for the steps of the 1031 exchange. An Internal Revenue Code (IRC) Section 1031 exchange allows the taxpayer to defer the federal and state capital gain and depreciation recapture when selling real or personal property held in the productive use of a business or investment when exchanged for property to be held in the productive use of a business or investment. Primary residences, partnership interests, indebtedness, inventory and stocks and securities are not eligible for 1031 consideration.

Qualified Intermediary

The QI is required to facilitate the 1031 exchange except in a two party exchange. The QI role is to create documentation for the taxpayer and third party to sign in accordance with the IRC requirements that supports the taxpayer’s intent to defer the federal and state capital gain taxes. Exchange funds are to be held in a manner that preserves principal and liquidity under the taxpayer’s tax identification number. The QI guides the taxpayer through the process, answering questions and doing their best to help the taxpayer successfully complete the 1031 exchange. The QI is indemnified from those taxpayer’s actions that may nullify the tax deferral. Unless the QI is a CPA or lawyer, the QI should not be providing tax or legal advice.

What to Expect in a 1031 Exchange

Initially, the QI is contacted to discuss the taxpayer’s transaction. Questions are asked that help the QI understand the type of exchange and property, hold time and the name of the titleholder with the intent of identifying potential problem areas. Often times in the initial consult, the outcome is that the 1031 exchange does not makes sense either because the taxpayer did not understand that all the net equity and debt retired, if any, must be replaced in the replacement property or due to a related party issue, the exchange is not feasible.

The QI should be readily accessible by phone or email. Preferably, the same QI or CES handles all the taxpayer’s calls. All questions should be answered within 12 hours of receipt. Exchange proceeds or the net equity from the sale should be held in a Qualified Escrow Account requiring dual signatures for disbursement, one from the taxpayer and one from the QI.

Once engaged, the QI works with your broker to review the Purchase and Sale Agreement (PSA) to make sure the agreement contains the necessary assignment language. Next, the QI works with your closing agent to prepare and send exchange agreements and settlement statement instructions. Wire instructions are provided to wire the exchange proceeds. The QI will provide the 45th and 180th calendar days along with identification instructions of how to identify the replacement property. Once the taxpayer has entered into a replacement property PSA, the QI works with the title company to prepare the second leg exchange agreements, settlement statement instructions and wire the proceeds once the taxpayer has authorized the disbursement. At the end of the exchange, a summary file is created to assist the taxpayer and their CPA to file the Internal Revenue Service form 8824, itemizing the 1031 exchange along with the taxpayer’s annual federal return.

The taxpayer should look to the QI to answer 1031 related questions. If the question is one the taxpayer’s CPA or tax attorney should answer, then the QI should suggest seeking their input. When vetting a QI, there are many questions to ask. Price is one of many and should not be the primary reason for selecting the QI. Knowledge, experience with the taxpayer’s particular type of exchange and responsiveness should be more important than price.

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QI Vetting Questions