When Do You Need a Qualified Intermediary for a 1031 Exchange?

Conducting a 1031 exchange provides an opportunity to indefinitely defer federal tax liability on gain from the sale of a piece of real estate. To qualify for indefinite tax deferral, an exchange must meet several requirements—including timing requirements related to the sale of the “relinquished” property and the acquisition of the “replacement” property. In most cases, meeting these timing requirements involves working with a 1031 qualified intermediary.

When is a 1031 Qualified Intermediary Required?

Working with a 1031 qualified intermediary is required when the taxpayer conducting a like-kind exchange is not directly exchanging the relinquished property for the replacement property. For example, if the taxpayer is planning to sell a relinquished property to one party and then buy a replacement property from another, working with a qualified intermediary will be necessary.

This is referred to as a “delayed exchange,” and it is by far the most common type of 1031 exchange. The opposite approach—acquiring a replacement property before selling a relinquished property (referred to as a “reverse exchange”) requires taxpayers to work with a qualified intermediary as well. Given this, working with a qualified intermediary will be required in most scenarios.

Why is this the case? Another requirement for like-kind exchange treatment is that the taxpayer never comes into possession of the proceeds from the sale of a relinquished property. As the IRS explains in Fact Sheet (FS) 2008-18 (while FS 2008-18 is outdated in certain respects, the following statements remain accurate):

“[T]aking control of cash or other proceeds before the exchange is complete may disqualify the entire transaction from like-kind exchange treatment and make ALL gain immediately taxable.”

As the IRS also explains:

“One way to avoid premature receipt of cash or other proceeds is to use a qualified intermediary or other exchange facilitator to hold those proceeds until the exchange is complete.”

As the IRS goes on to make explicit, “[y]ou cannot act as your own facilitator.” Thus, for taxpayers who plan to conduct a delayed exchange, engaging a qualified intermediary is necessary to preserve their eligibility for indefinite tax deferral under Section 1031 of the Internal Revenue Code.

When Should You Engage a Qualified Intermediary for a 1031 Exchange?

Given the importance of timing when conducting a 1031 exchange, when should you engage a qualified intermediary?

The most important fact to keep in mind is that while it is never too early to engage a qualified intermediary, it can be too late. If you put a transaction in motion and sell a relinquished property before you have a qualified intermediary prepared to take possession of the sale proceeds on your behalf, you can immediately and irrevocably lose your indefinite tax deferral eligibility.

On the other hand, there is no harm in getting ready early, and many 1031 qualified intermediaries (including ours) offer additional facilitation services. For example, in addition to managing the escrow of funds for our clients’ like-kind exchanges, we also offer services such as:

• Assistance with managing and meeting the timing requirements for like-kind exchanges under Section 1031;
• Assistance with structuring delayed exchanges, reverse exchanges, and build-to-suit exchanges to comply with Section 1031;
• Assistance with properly documenting the “identification” of replacement properties for purposes of Section 1031 compliance;
• Management of the “parking” of relinquished and replacement properties when necessary to preserve like-kind exchange eligibility; and,
• Documentation of other eligibility requirements (i.e., holding properties “for investment”) for like-kind exchange treatment.

Since taxpayers generally don’t get a second chance when attempting to secure indefinite tax deferral through a like-kind exchange, it is critical to take an informed and proactive approach to managing Section 1031 compliance. An experienced, qualified intermediary will help taxpayers manage the process with confidence and ensure they are prepared to withstand scrutiny from the Internal Revenue Service (IRS) if necessary. If the IRS rejects like-kind exchange treatment for a transaction after a taxpayer has claimed tax deferral, this can have serious consequences.

Schedule a Call with a Qualified Intermediary at 1031 National Services

If you need more information about working with a qualified intermediary to conduct a like-kind exchange, we invite you to get in touch. We have extensive experience guiding taxpayers through delayed exchanges, reverse exchanges, and build-to-suit exchanges in accordance with Section 1031. To schedule a call with a qualified intermediary at 1031 National Services, please call 888-872-1031 or contact us online today.