The Role Of the Qualified Intermediary

The role of the Qualified Intermediary is essential to completing a successful and valid delayed exchange. The Qualified Intermediary is the glue that puts the buyer and seller of property together into the form of a 1031 Exchange. Where such an intermediary (often called an exchange facilitator) is used, the intermediary will not be considered the agent of the taxpayer for constructive receipt purposes notwithstanding the fact that he may be an agent under state law and the taxpayer may gain immediate possession of the money or property under the laws of agency.

In order to take advantage of the qualified intermediary “safe harbor” there must be a written agreement between the taxpayer and intermediary expressly limiting the taxpayer’s rights to receive, pledge, borrow or otherwise obtain the benefits of the money or property held by the intermediary.

A Qualified Intermediary is formally defined as a person who is not the taxpayer or a disqualified person and who enters into a written agreement (the “exchange agreement”) with the taxpayer. The Qualified Intermediary acquires the Relinquished Property from the taxpayer, transfers the Relinquished Property to the buyer, acquires the Replacement Property and transfers the Replacement Property to the taxpayer. The Qualified Intermediary does not actually have to receive and transfer title as long as the legal fiction is maintained.

The Intermediary can act with respect to the property as the agent of any party to the transaction and further, an Intermediary is treated as entering into a contract for sale if the rights of a party to the contract are assigned to the Intermediary and all parties to the contract are notified in writing of the assignment on or before the date of the relevant transfer of property. This provision allows a taxpayer to enter into a contract for the transfer of the Relinquished Property and thereafter to assign his rights in the contract to the Intermediary. Providing all parties to the agreement are notified in writing of the assignment on or before the date of the transfer of the Relinquished Property, the intermediary is treated as having entered into the contract and after completion of the transfer, as having acquired and transferred the Relinquished Property.

There are no licensing requirements for Intermediaries established by the IRS. They need merely be not an unqualified person as defined by the Internal Revenue Code in order to be qualified. The Code prohibits certain “agents” of the taxpayer from being qualified. Accountants, attorneys and realtors who have served taxpayers in their professional capacities within the prior two years are disqualified from serving as a Qualified Intermediary for a taxpayer in an exchange. Related parties are also disqualified.

Criteria for Selecting a Qualified Intermediary

Intermediaries serve as a limited purpose depository institution and hold all of the Exchange Cash during the course of a 1031 Exchange. As a result, Intermediaries usually hold substantial sums of money on behalf of their exchange clients. With the exception of a few states, including Nevada, California, Idaho, Colorado and Arizona, there are no federal or state regulations or supervision of Intermediaries. Taxpayers are unsecured creditors when an Intermediary becomes bankrupt or insolvent. Funds held by Intermediaries are invested in a variety of ways, including pooled cash funds with stock brokerages and segregated liquid asset money market accounts. Obviously, the selection of an Intermediary who will be entrusted with the funds of a 1031 Exchange is an important matter.

Intermediaries offer widely varying services and have widely varying professional training, skills and competence. Intermediaries are usually attorneys, tax accountants, bank affiliates, title company affiliates or realtors. Many Intermediaries have no training as a tax professional or as an exchange professional and offer no consultation to a taxpayer on tax issues related to the exchange or on the technical requirements for completion of a successful exchange. Some Intermediaries simply bank funds.

Intermediaries take their fees or compensation in a variety of ways. Some Intermediaries charge little or no fees for their services and retain all or a portion of the interest earned on the funds in their possession. Some Intermediaries charge higher fees for their services and forward all interest earned on funds in their possession to the client at the end of the exchange. Some do a little of both. Interest earned on funds held by an Intermediary can vary widely also, depending on where the funds are invested or held on deposit.

Here are some of the things taxpayers should consider when engaging the services of an Intermediary:

  • Does the Intermediary have tax professionals or Certified Exchange Specialists capable of consulting you on 1031 tax issues?
  • Does the Intermediary deposit Exchange Funds in segregated and FDIC insured accounts?
  • Is the Intermediary a member of the Federation Of Exchange Accommodators, a professional organization that expects its members to perform services at the highest level of competence and trust?
  • Does the Intermediary have experience and a verifiable reputation?
  • Is the Intermediary willing to meet with you, consult with you on exchange strategies, issues and execution of exchange documents?
  • Is the Intermediary bonded with a fidelity bond?
  • Are Exchange Funds available for disbursement within 24 hours?
  • Does the Intermediary manage closings in order to avoid inadvertent boot and related taxes, which can cost you more than the fees they charge?
Categories: Federal Tax Articles, Like Kind (IRC 1031), Tax Articles, Tax Free Exchanges