A Qualified Intermediary is a critical third-party entity in a 1031 exchange. The purpose of a Qualified Intermediary is to facilitate the exchange process and help ensure that it meets the IRS requirements for tax deferral.
Here’s how a Qualified Intermediary functions in a 1031 exchange:
- Initial Sale: When a property owner wants to initiate a 1031 exchange, they must first sell their existing property (referred to as the relinquished property). Instead of receiving the proceeds from the sale directly, the proceeds are transferred to the Qualified Intermediary, who holds them in a segregated account.
- Identification Period: Within 45 days of the sale of the relinquished property, the property owner must identify potential replacement properties to purchase. The Qualified Intermediary plays no role in the identification of these properties, but they are responsible for documenting the identification.
- Acquisition of Replacement Property: The property owner has 180 days from the sale of the relinquished property to purchase one or more replacement properties. The Qualified Intermediary facilitates the purchase by using the funds held in the escrow account to acquire the replacement property.
- Closing the Exchange: Once the replacement property is acquired, the Qualified Intermediary transfers it to the property owner. The exchange is considered complete, and the property owner can defer the capital gains taxes that would have been due on the sale of the relinquished property.
It’s important to use a Qualified Intermediary in a 1031 exchange to maintain the tax-deferred status of the exchange. If the property owner were to receive the sale proceeds directly, it could trigger a taxable event. Additionally, the property owner must adhere to specific IRS rules and deadlines regarding identification and acquisition of replacement properties, which the Qualified Intermediary helps with.
Qualified Intermediaries are typically companies or professionals experienced in facilitating 1031 exchanges, and they charge a fee for their services. It’s crucial to choose a reputable and qualified QI to ensure the successful completion of a 1031 exchange and to comply with IRS regulations.
