The use of a qualified intermediary (QI) is mandatory in most 1031 exchanges, and the services a QI provides are extremely valuable. However, a lot has to happen before a QI steps into a deal. To ensure an exchange transaction is as advantageous as possible, it is important for investors to know exactly what a QI does and the specific qualified intermediary requirements.
Meeting 1031 Qualified Intermediary Requirements
Participants in a 1031 exchange must use a qualified QI except when exchanging deeds to like-kind investment properties of equal value, and nothing more. That is a rare occurrence. As such, the IRS requires investors to use a QI when:
- They are not relinquishing and replacing properties simultaneously.
- They are acquiring properties of greater or lesser value than the relinquished property.
- There are other steps to consider in an exchange, such as those involved with an improvement exchange or tenancy-in-common.
The first rule of 1031 exchanges is that the QI must be engaged before the sale of the relinquished property. The exchange cannot be made retroactively since it is the QI that will execute the sale. Before engaging a QI, the investor should develop a comprehensive financial plan and conduct a cost analysis of the 1031 exchange.
A 1031 exchange is a lot of work as it is more complicated than a simple sale of a real estate asset. The individual motivations an investor must have for engaging in a 1031 exchange, whether it be market conditions, tax benefits, and/or financing (among many others), must outweigh the added complexity of engaging in the exchange.
Since the purpose of the exchange is to defer capital gains taxes, the amount of the potential tax obligation should be compared to the cost of the exchange itself. This is far more complex than just calculating the potential cost of a QI. One may be leveraging funds that would have gone to pay taxes, so the return on the funds invested in a replacement property have to be estimated separately from the proceeds from the property sale. If the investor considering the exchange possesses capital losses on other investments, the benefit of a 1031 exchange may be negligible. This all implies some prognostication, of course, so top-quality financial advice should be sought.
Select an Experienced QI
Care should be taken in the selection of a QI. Mistakes made by the QI could invalidate an exchange. The QI will also be handling your money for a considerable period of time, so you’ll want to be sure that he or she is solvent and trustworthy, but not too closely associated with you. Your relatives and “agents” cannot serve as your QI.
The QI will execute the sale of the relinquished property, including escrow and title search, and make sure that you do not receive constructive receipt of the funds from the sale. He or she will also strive to keep you on schedule, since missed deadlines are fatal to a 1031 exchange. When a replacement property has been chosen, the QI acquires and then deeds it to you.
A 1031 exchange that is well planned and executed will allow you to not only defer taxes, but also to grow your wealth faster than you would otherwise. The engagement of legal and financial advisers, in addition to the QI, is well worth it to achieve those goals.
At CWS Capital Partners, we are a fully integrated multifamily real estate investment management firm that offers everything from due diligence and multifamily real estate valuation to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We also own and manage luxury multifamily investment communities in major markets around the country and employ a team of experts who can help you hone your investment strategy.
For more articles like this one, check out our 1031 exchange blog posts.
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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
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