What is a QI (Qualified Intermediary) -

While it may technically be possible to successfully pull off a 1031 exchange despite contacting a Qualified Intermediary the day before the close of escrow on the property to be relinquished, waiting until the last minute needlessly increases the risk of mistakes. For example, the escrow company might accidentally transfer funds to the investor, causing them to become irreversibly taxable.

An experienced QI will be able to clearly articulate the 1031 exchange property identification rules, walk an investor through closing statements, explain how property titles ought to be handled, and provide a rundown of closing requirements.

Errors and Omissions Insurance (E&O). Qualified Intermediaries are subject to human error just like the rest of us. Even honest mistakes made by honest companies can result in costly legal fees or a QI having to come out of pocket to make up for a mistake, which only increases their risk of bankruptcy. It is therefore important for QIs to insure against the risk of errors and omissions with a policy carried by a reputable insurer. There shouldn’t be any gaps in its coverage, and it should cover settlements, judgements, and legal fees.

Fidelity Bonding. In addition to insuring against honest mistakes, Qualified Intermediaries should insure against fraud, forgery, and theft. This policy should also be carried by a reputable insurer so that the investor can be reimbursed if their capital is lost as a result of this kind of infidelity.

Specify Treatment of Funds. The agreement between the QI and the investor should clearly and thoroughly specify how the QI will handle the investor’s funds at each stage of the process.

Provide a Fair & Transparent Fee Structure. The exact nature of the QI’s fees should be disclosed, including any interest that might be earned during the exchange period (which should only be at issue if deposits do not exceed the FDIC insurance limit). Typical fees can range from $500–$2,500 for delayed exchanges and $2,500–$7,500 for reverse exchanges, due to the increased complexity and risk of such transactions.

Specify the Property Identification Rule in Play. The exchange agreement should specify which of the three property identifications rules the investor will be complying with, including details about the timeframe.

Segregation of Accounts. A QI should not hold investor funds in their own company accounts or comingle funds from separate investors in common accounts so that even if a QI were to declare bankruptcy an investor’s funds will be protected from delay or seizure and the investor may still be able to complete their exchange.

Trust or Escrow Accounts. Recent court rulings have treated funds held in accounts under a QI’s name as corporate funds and therefore part of their bankruptcy estate. However federal regulations allow Qualified Intermediaries to hold investor funds in qualified trust or escrow accounts with trustees, so that they are treated as fiduciary funds rather than corporate funds, protecting them from bankruptcy on the part of the QI.

Dual Sign Off on Accounts. Since an investor cannot take actual or constructive receipt of their funds, the money must be held in an account that requires the QI’s approval on transfers. However, there is no need for the QI to be the sole signer on the account. Dual signoff complies with federal regulations while protecting investors.

Non-Interest Bearing Accounts if Deposits Exceed FDIC Limits. Although federal regulations allow an investor to benefit from an interest-bearing account, their Qualified Intermediary may take all or part of that interest as a fee. This can make interest-bearing accounts attractive to investors and QIs, however if deposits exceed the FDIC insurance limit and something happens to the funds, the investor may lose all of their funds. Putting all of an investor’s capital at risk is not worth it.