A Qualified Intermediary (“QI”), sometimes known as an accommodator or facilitator, is a critical part of any 1031 Exchange. Choosing the right QI is key to executing a successful transaction. The QI is an entity (person or company) who, for a fee, acts to facilitate the 1031 Exchange by entering into a contractual agreement for the exchange of properties.
Who Can’t Serve as a QI?
It's important to know that neither the taxpayer nor a “disqualified person” may serve as a QI. A “disqualified person” is the agent of the exchanger at the time of the exchange. A person who has acted as the taxpayer’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker, within the two-year period preceding the date of the transfer of the first relinquished property, is treated as an agent of the exchanger, and thereby a disqualified person. If an attorney has provided tax or legal services to the exchanger within the prescribed two-year period, the attorney is a disqualified person.
Why a QI is so Important
Perhaps one of the most important services the QI provides is to help 1031 Exchange investors avoid the damaging mistake of “constructive receipt.” Constructive receipt is a tax concept in which a taxpayer is liable for income, which may not have been physically received, but has been credited to the taxpayer’s account or otherwise becomes available for him or her to draw upon in the future following the sale of a relinquished property.
The QI's Responsibilities
The 1031 exchange QI is responsible for:
- Preparing the 1031 Exchange legal agreements and related transaction documents in order to properly structure the transaction
- Receiving, holding and safeguarding the 1031 Exchange funds throughout the transaction, and
- Advising, coordinating or consulting on the implementation of the 1031 exchange transaction to ensure compliance with the Internal Revenue Code, Treasury Regulations and related Revenue Rulings and Procedures
What to Look for in a QI
A significant amount of care should be taken when you are selecting a QI because of the crucial role this entity plays in the administration of the 1031 Exchange transaction. This particular industry where QIs operate is unregulated and there are potential pitfalls that could put you at risk of a failed exchange, so we recommended evaluating several facets of a QI before addressing who might have the lowest fees.
Here are a few of those areas to consider:
Experience and History
The 1031 Exchange process can be quite intricate, and it takes a competent, well-established QI to provide the necessary services for investors to comply with the rules and requirements. When evaluating QIs, you should ensure they have at least 10 years of experience and are fully competent in all aspects of the 1031 Exchange process. You should also request historical summaries of their completed transactions as well as references and testimonials.
Policies, Procedures and Internal Audit Controls
Detailed policies, procedures and internal audit controls are critical in minimizing the risk of loss to 1031 Exchange funds and assets while being held by the QI. Established providers will have sophisticated processes that typically include multiple checks and balances to ensure the QI is taking into consideration the needs and interests of clients first.
Separate, Segregated Qualified Trust Accounts
It is typical for active QIs to facilitate multiple 1031 Exchanges simultaneously, so it’s important they segregate the funds for each exchange into separate accounts that are held distinctly for the benefit of each individual exchanger. Segregated accounts guard the funds of the QI’s clients if a QI runs into financial difficulty or declares bankruptcy.
Safety of 1031 Exchange Funds
Another important element is the protection of the 1031 Exchange funds while being held and managed by a QI. Fidelity bonding safeguards against intentional wrongful acts, such as fraud, theft and forgery. Your selected QI should maintain fidelity bonding from a reputable provider to transfer the risks associated with deliberate wrongful acts to another party.
Errors and Omissions
QIs should maintain an Errors and Omissions (E&O) insurance policy from a reputable insurance provider. E&O insurance will protect you and your QI from risks associated with actual or perceived errors and omissions performed by the QI during the exchange period. Although sophisticated internal controls and processes can minimize the risk of loss, mistakes are always possible.
It is always acceptable for you to request a copy of the QI’s insurance policies, both E&O insurance and fidelity bonding, in order to verify the insurance underwriter, the policy limit, and policy term/expiration date, to ascertain whether the policies are sufficient.
Qualified Intermediaries are essential to the 1031 Exchange process and we’ve discussed several considerations you should be aware of when selecting a QI for your exchange. In addition to complying with the IRS guidelines for completing a successful exchange, it is in your best interest to know what to look for in a QI to protect your capital and tax-deferred status during the exchange process. Referring to the key components we’ve covered here can help you find the right QI for your unique situation.
Feel free to contact our team if you have any more questions about your 1031 Exchange.