Each year, nearly 250,000 1031 exchanges are filed in the U.S., representing over $740 billion in real estate value. A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows property owners to defer capital gains taxes when selling an investment or business-use property, as long as they reinvest the proceeds into a qualifying “like-kind” property.
To maintain the tax-deferred status of the transaction, the IRS requires that the seller does not receive or control the proceeds from the sale. Instead, those funds must be held by a neutral third party known as a Qualified Intermediary (QI). The QI’s responsibilities include preparing legal documents, securing sale proceeds in a dedicated escrow account, and ensuring compliance with the strict 45- and 180-day deadlines set by the IRS.
Despite the QI’s critical role in the exchange process, there is no federal licensing or regulatory body overseeing the industry. Only a few states, such as Idaho, Nevada, Maine, and Virginia, impose specific legal standards on QIs. This lack of oversight makes it essential for sellers to thoroughly vet and compare potential intermediaries.
A qualified and experienced QI should not only understand the legal and logistical aspects of the exchange but should also offer transparency, adequate insurance coverage (such as fidelity bonds and E&O insurance), and ideally utilize Qualified Escrow Agreements that require dual authorization for fund disbursement. Selecting the right intermediary helps protect your funds, ensure IRS compliance, and maximize the benefits of your 1031 exchange.
Who Can Be a Qualified Intermediary?
A qualified intermediary can be anyone who hasn’t represented you directly in a professional capacity in the last two years. So not your tax attorney, legal attorney, accountant, real estate agent or broker, or employee. But you could hire your bank, title insurance agent or an escrow agent as long as they’ve only performed routine functions for you, like they would any other customer.
If you’re not comfortable performing an internet search for a local qualified intermediary to interview, ask your accountant or attorney for recommendations. You can also search the website for the Federation of Exchange Accommodators, an organization that offers certification courses and continuing education for qualified intermediaries.
Who Should be a Qualified Intermediary
The principal duties of a qualified intermediary include:
- Sells your home.
- Collects funds from your sale and holds them in a separate escrow account.
- Ensures you submit your list of possible exchange properties within 45 days of your property sale.
- Ensures you close on the sale of your replacement property within 180 days of selling your house.
- Purchases your exchange property.
- Files all of the appropriate paperwork.
In addition to these responsibilities, it’s crucial that your QI follows best practices for fund protection and regulatory compliance. Look for intermediaries who:
- Use Qualified Escrow Agreements (QEAs) that require dual authorization (ie. both your approval and the QI’s) before any funds can be withdrawn. This setup significantly reduces the risk of fraud or unauthorized access to your exchange funds.
- Employ Certified Exchange Specialists® (CES) designated by the Federation of Exchange Accommodators (FEA). This certification demonstrates that the QI has passed rigorous testing, commits to continuing education, and adheres to a code of ethics, ensuring your exchange is handled by a knowledgeable professional.1031 exchange agent
The rules governing 1031 exchanges are complex and strict so you want to make sure you hire a competent and honest qualified intermediary to help you through the process.
Here are some questions you want to ask before you sign their contract.
How many exchanges have you completed in the last five years and what was the total dollar value of the exchanges for each year?
How and where will the funds be held?
The proceeds from your property sale should be held in separate and segregated qualified trust accounts or qualified escrow accounts. Withdrawals from these accounts are strictly monitored, requiring a written request from the qualified intermediary and authorization from you. If your qualified intermediary is an escrow agent, you want your funds held with a third party escrow firm to make it harder for fraud to occur.
Do you carry fidelity and surety bond coverage as well as E&O insurance?
Fidelity bonds cover you in the case that your funds are lost due to theft, fraud or embezzlement. Surety bonds cover you if your qualified intermediary files bankruptcy or goes into receivership during your transaction, making them unable to fulfill their duties. And E&O is professional liability insurance that covers you in the case that the above coverage policies don’t cover the extent of the damages you incur because of your qualified intermediary’s misdeeds.
Are you certified by the Federation of Exchange Accommodators (FEA)? Although the only states that require qualified intermediaries to get certified are Idaho, Maine, Nevada and Virginia, the FEA offers a certification process that is similar to the process real estate agents go through. To achieve certification, a qualified intermediary must pass a test, meet continuing education requirements and abide by a strict code of ethics.
Qualified intermediaries are responsible for ensuring 1031 exchanges are completed within a tight timeframe and according to the complex rules regulating the transactions. It’s an important job and you want to make sure you hire the right professional to do it. Make sure you interview at least two or three different companies and get satisfactory answers to your questions before you make your final decision.
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