Who is a Qualified Intermediary?
The role of Qualified Intermediary (QI) is very crucial role in successful completion of a 1031 Exchange.
Someone who is linked to the taxpayer, either personally or financially within the two years prior to the close of escrow in a 1031 exchange cannot serve as the QI (including employees), unless those services remained services for the taxpayer about exchanges of property proposed to qualify for non-recognition of loss or gain under section 1031. This indicates that the taxpayer is only entitled to engage the services of their current accountant, attorney, broker, investment banker, broker or real estate agent. A Qualified Intermediary should be insured and bonded against omissions and errors. An extensive educational background in finance, law or tax is imperative. At present only Nevada mandates a licensed Qualified Intermediary.
The 1031 Qualified Intermediary begins with a written agreement with the taxpayer where they are responsible for assigning the relinquished property to the buyer and assigns the replacement property to the taxpayer following the 1031 Exchange agreement. They handle the gains from the sale of the relinquished property in an escrow account to secure that the Taxpayer never gets an actual or constructive receipt of the sale proceeds.
Finding a trusted Qualified Intermediary
When selecting a Qualified Intermediary, it is essential to examine the fact that there is little or no control governing these entities. Hence, administering due diligence is vital to guarantee that the exchange funds are being kept securely and the Exchanger’s (entity/individual deferring taxes via 1031 Exchange) reserves are preserved in the event the Qualified Intermediary can’t render the funds at closing. Also, it’s critical to make sure the QI being used has a robust infrastructure and is highly qualified. 1031 Qualified Intermediary should also have a vast experience in handling 1031 Exchanges for investors in the past.
A Qualified Intermediary is accountable for successful completion of the following activities in a 1031 Exchange:
Understanding Tax Ownership for Limited Liability Company
If a property is held in by a limited liability company the tax ownership depends on how the LLC is characterized for federal income tax purposes. If the company has chosen to be taxed as a corporation, then the company will hold the tax ownership. If there is more than one person in the limited liability company and it has not selected to be considered as a corporation for tax purposes, then it is managed as a partnership for federal income tax purposes making the company tax owner of the property. If, however, Mark is the sole member of the LLC and the company has not chosen to be considered as a corporation for federal tax purposes, then Mark will be the owner of the property for federal income tax purposes. As per federal tax law, a single member limited liability company is a “disregarded entity” and the assets are reviewed as being owned by the sole member of the company.
Revocable trusts are another sector where tax ownership, state ownership, and vesting may differ. During the lifetime of a person who establishes a revocable trust (a Grantor) and during the time he or she maintains the right to cancel the trust, federal law considers the Grantor as the tax owner of assets preserved in the trust. So, as the Grantor, Mark becomes the tax owner of assets held in the revocable trust, however, the trust is treated as an entity under state law and for purposes of vesting and ownership of trust property. Thus, Mark can sell property owned by his revocable trust as per a 1031 exchange and acquire replacement property in his own name.
In most of the preceding examples, a valid 1031 exchange was achieved even in situations where the vesting of the relinquished property did not match the vesting of the replacement property. Thus, the idea that vesting of the relinquished property and the replacement property must be the same is not an essential requirement. We only need to ensure that the tax owner of the relinquished property takes tax ownership of the replacement property.
- Procuring the Relinquished Real Estate Property from the taxpayer himself.
- Assigning the Relinquished Real Estate Property to the buyer himself.
- Acquiring the Replacement Real Estate Property from the seller himself.
- Transferring the Replacement Real Estate Property to the taxpayer himself.
- The Qualified Intermediary can truly achieve all these without ever holding title to either of the properties. The Qualified Intermediary is reliable for accurately filling out the appropriate tax forms for the client. In a typical exchange, the 1031 Qualified Intermediary ideally presents three different documents
Number 1: The Exchange Agreement.
Number 2: An assignment.
Number 3: A notice.
The 1031 Exchange Agreement is a legal contract between the QI and the Client that establishes the guidelines and rules governing a 1031 Exchange. This needs to be followed religiously to ensure that the 1031 Exchange gets approved. The assignment of the “sales contract” to the Qualified Intermediary needs to be in place to avoid any future disputes. This is mandated because, in theory, the Qualified Intermediary acts as a proxy while selling the property. The third document the Qualified Intermediary produces is a notice to the other party advising that the transaction is being done for a 1031 exchange. The idea behind the notification to the other party is to ensure that the 1031 exchange was in place at the closing.
- An exchanger needs to be cautious and should only seek services of a knowledgeable Qualified Intermediary before going into the 1031 Exchange. There are thousands of QI rendering “like-kind” 1031 exchange services today. Most of the Qualified Intermediaries lack the required bonding, insurance, transactional structure, financial backing, and internal safety procedures that are required of them.