Introduction
Understanding the role of a Qualified Intermediary is an essential step in learning about the 1031 exchange process. Assuming you’ve done some prior research on like-kind exchanges, you may have seen our article: How to Do a 1031 Exchange: Rules & Definitions for Investors. If you haven’t, that’s a great place to start. It provides an extensive overview of like-kind exchanges, including easy-to-understand definitions for investors. Keep reading if you are ready to learn more about a 1031 intermediary role, responsibilities, fees, and tips for finding a good one.
What is a Qualified Intermediary?
A Qualified Intermediary (QI) is sometimes referred to as an “Exchange Facilitator” or “Exchange Accommodator.” In essence, Qualified Intermediaries act as third-party fiduciaries who manage or hold money or assets for another person.
A fiduciary is a trusted relationship between a trustee and a beneficiary. The QI ensures all the rules are followed and deadlines are met to stay compliant with the IRS’s exchange process.
Is a Qualified Intermediary Required For a Like-Kind Exchange?
The short answer is yes. Whenever an investor pursues a like-kind exchange strategy, they must enter into an agreement with a Qualified Intermediary before selling their existing property. The main reason is that the investor cannot access the money from the sale of their property at any time during the exchange process.
Instead, the funds are held by a QI that facilitates the exchange to protect tax deferral benefits and finalize the process. If an investor does not utilize a Qualified Intermediary or has possession of the funds from the sale at any time, they’ll be disqualified from doing a 1031 exchange, and any profits will be taxed as capital gains.
Terms to know: “Relinquished” property refers to the asset you sell or give up. “Replacement” property refers to the property you are buying to replace the one you are selling.
What Does a 1031 Facilitator Do?
A 1031 exchange facilitator is in charge of several tasks during the exchange process. A QI will hold the money throughout the exchange process and their key duties include the following:
- Obtain the relinquished property from you
- Transfer the relinquished property to the new buyer
- Obtain the replacement property from the seller and transfer the replacement property to you
- Support the investor throughout the exchange process
- Coordinate with you, your accountant and real estate attorney
- Handle all deposits and disbursements from the sale proceeds
- Help prepare legal paperwork and tax documents
- Give instructions and necessary documents to the title company
- Manage the property closings
- Verify that your like-kind exchange follows the IRS’s guidelines
As you can see, using a Qualified Intermediary is not only required to complete a successful 1031 exchange, but they can also be an extremely helpful resource to help you avoid the many risks associated with like-kind exchanges. This is why it’s so important to find an experienced 1031 facilitator.
Who Can be a Qualified Intermediary For a 1031 Exchange?
The IRS hasn’t outlined rules for what qualifies someone as a Qualified Intermediary. However, there are rules as to what disqualifies a person. For instance, if someone has acted as your “agent” at any time during the last two years, they will not qualify. The following are disqualified from being your QI:
- You
- Your employer
- Your attorney
- Your tax advisor
- Your real estate broker
- Your investment broker
- Your family members
Because a Qualified Intermediary acts as a third party, they must be completely neutral and independent. There must be no prior relationship between you and your QI or the exchange will be invalid, and thus, taxable.
Qualified Intermediary 1031 Exchange Fees
The total cost of doing a like-kind exchange can vary depending on which type of exchange you want to do. For example, if you are doing a Reverse 1031 exchange, the fees might be higher than, say, the more popular Delayed exchange. Reverse exchanges can present additional risks and costs because they are more complex.
The complexity of your exchange will determine how much you can expect to pay for a QI. The more properties involved in the exchange, the higher fees you’ll likely incur.
Three Types of Qualified Intermediaries
How much a Qualified Intermediary charges is based on whether they work for an institution or an independent company. Banks or title insurance companies typically offer “Institution” QI services, while “Non-Institution” QIs are independently owned companies. These independent companies provide exchange services but aren’t subsidiaries of a bank.
Online companies that specialize in exchanges are generally non-institution QIs. Small law firms and large national firms may be either institutional or non-institution QIs. Each type of QI offers differing levels of service, cost, efficiency, and expertise.
Two Sets of QI Fees
The first set of fees that a Qualified Intermediary will charge will cover the initial transaction—the transfer of your relinquished property to your replacement property. These upfront costs are referred to as set-up and administrative fees. If the exchange involves multiple properties, there could be additional costs for each property.
1. Set-Up & Administrative Fees
Generally speaking, institutional QIs charge an initial transaction fee between $800 and $1,200. The QI may also charge between $200 and $400 for each additional property participating in the exchange.
To incentivize investors, non-institutional Qualified Intermediaries who work for independent companies often charge lower upfront fees. Initial fees generally range from $600 to $800.
It’s important to note that these upfront fees only make up about a third of how much a QI makes when working on an exchange. This goes for both institutional and non-institutional QIs. Interest income makes up the other two-thirds (ish) of a QI’s profits.
2. Interest Income
The second and most substantial way an exchange intermediary makes money is through interest income. A key job of the QI is to hold the funds from the sale of the relinquished property until a new property has been purchased. These funds earn interest the whole time a 1031 exchange is being processed. When an exchange is complete, the QI will take a percentage of the interest income as their second fee.
Example: You sold an investment property and got $400,000, which was transferred to your QI to hold. 1031 exchanges allow investors up to 180 days to complete the transaction. Let’s say you take the entire time to find and purchase a replacement property. During those 180 days, the 1031 facilitator relinquished property funds in an account earning interest. If the interest rate is 2 percent, the interest income would be $4,000. The QI would take all or a portion of that interest income as part of their fee structure.
Some Qualified Intermediaries charge higher upfront fees but take a lower percentage of interest income. Others may offer lower set-up fees but take a higher percentage of interest income.
Investor tip: Because QI fees can be structured differently (institutional vs non-institutional), make sure you know exactly what services you’ll be paying for during your exchange before entering an agreement.
3. Other Fees
In addition to income interest, set-up, and administrative fees, you should be aware of other miscellaneous costs that could pop up during the exchange process. Things like courier fees, overnight deliveries, wire transfer fees, etc., may show up on the final bill from your 1031 exchange intermediary.
How to Find a Great Qualified Intermediary
A great Qualified Intermediary should be highly experienced with the type of 1031 exchange you wish to accomplish. Ideally, your QI has performed thousands of successful exchanges and has lots of positive client reviews. Here are a few ideas for how to find a great QI:
- Get a Referral – ask an escrow officer, friends, or family
- Research Online
- Check out client reviews on third-party sites
- View and connect with the vetted Qualified Intermediary frequently used by our members here.
As different types of exchanges require more work than others, performing due diligence on QIs and their fees will ensure that you won’t be surprised when you get their final bill.
How RealWealth Can Help
The process of a 1031 exchange may seem daunting and sometimes costly, but the tax benefits far outweigh the total cost. That’s why real estate investors continue to use all types of 1031 exchanges to avoid paying capital gains taxes (at least until a later date.) A Qualified Intermediary plays a critical role in facilitating a successful exchange.
When you join RealWealth, one of the benefits you receive is full access to our list of industry contacts, which includes a prominent 1031 facilitators who has worked extensively with real estate investors like you. Connect with them here.
