A Qualified Intermediary (QI), also referred to as an Accommodator or Facilitator, is an entity that facilitates Internal Revenue Code Section 1031 tax-deferred exchanges. The role of a QI is defined in Treas. Reg. §1.1031(k)-1(g)(4).
Understanding the role of a qualified intermediary
Broadly speaking, a QI performs three groups of tasks:
- Prepares the legal agreements necessary to properly structure a 1031 exchange.
- Holds and safeguards your money from the sale of a property (i.e., your 1031 proceeds) until you close on a replacement property.
- Ensures that your exchange complies with the Internal Revenue Service’s rules.
In most circumstances, the use of a Qualified Intermediary is required to successfully complete an IRC Section 1031 tax-deferred exchange. Treasury Regulation §1031.1031(k)-1(g)(4)(iii) refers to the entity that facilitates a 1031 exchange as a Qualified Intermediary. A Qualified Intermediary is defined as follows…
A Qualified Intermediary (“QI”) is a person who:
- Is not the taxpayer or a disqualified person;
- Enters into a written agreement with the taxpayer (the exchange agreement) under which the qualified intermediary:
- Acquires the relinquished property from the taxpayer;
- Transfers the relinquished property to the buyer;
- Acquires the replacement property from the seller;
- Transfers the replacement property to the taxpayer.
- The exchange agreement must expressly limit the taxpayer’s rights to receive, pledge, borrow, or otherwise obtain benefits of money or other property held by the qualified intermediary. (See Treasury Regulations §1031.1031(k)-1(g)(4)(i).)
The use of an experienced qualified intermediary can significantly reduce the complexity of an exchange by assuring the proper execution of required documentation. The qualified intermediary industry is not regulated nationally. Consequently, the careful selection of the qualified intermediary is essential to ensure the highest level of expertise and security of funds.
What should an investor look for in a 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.
If you are unsure of the role of Qualified Intermediary or why you need a Qualified Intermediary, please give Exclusive Financial Resources a call at (980) 242-2533, email Louis Herford at Louis.Herford@ExclusiveFinancialResources.com or schedule a 15-minute discussion here.