Summary: In this article, learn about the role of a Qualified Intermediary for a 1031 exchange. Topics also include: when and why a Qualified Intermediary is required, the responsibilities of a QI, exchange costs and QI fees, and how to find a great Qualified Intermediary.
Introduction
1031 Exchanges are an excellent tax strategy that many investors use as a way to defer paying capital gains taxes on the profits made from the sale of a property. But it’s not a do-it-yourself project. It ‘takes a village’ as they say, and the exchange process is no different. While it may not take an entire village, it does take the help and expertise of others.
Understanding the role of a qualified intermediary is an important step in learning about the 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 to know.
In this article, we will explain what a qualified intermediary is, their role, responsibilities, and why they are essential to completing a successful exchange.
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What is a Qualified Intermediary?
A QI is sometimes referred to as an “Exchange Facilitator” or “Exchange Accommodator”. In essence, Qualified Intermediaries act as third party fiduciaries who take care of or hold money or assets for another person.
A Fiduciary is basically a trusted relationship between a trustee and beneficiary. The QI ensures all the rules are followed and deadlines are met in order 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 have access to 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 in order 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 are selling or giving up. “Replacement” property refers to the property you are buying to replace the one you are selling.
What Does a QI Do?
A 1031 exchange facilitator is in charge of a number of tasks during the exchange process. A QI will hold the money throughout the exchange 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, and
- 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 a really experienced QI.
Who Can be a Qualified Intermediary For a 1031 Exchange?
The IRS hasn’t outlined rules for what qualifies someone to be a Qualified Intermediary. However, there are rules as far as 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, and
- 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 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 institution or non-institution QIs. Each type of QI will offer 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. That is, the transfer of your relinquished property with your replacement property. These are your upfront costs referred to as set-up and administrative fees. If the exchange involves multiple properties, there could be additional costs for each property.
Set-Up & Administrative Fees
Generally speaking, institutional QIs will charge an initial transaction fee anywhere from $800 to $1,200. On top of that, the QI may charge between $200 to $400 for each additional property participating in the exchange.
To incentivize investors, non-institutional Qualified Intermediaries that work for independent companies will often charge lower upfront fees. Initial fees generally range from $600-$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.
Interest Income
The second and most substantial way an exchange intermediary makes their 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. The whole time a 1031 exchange is being processed, these funds are earning interest. When an exchange is complete, the QI will take a percentage of the interest income as their second fee.
Picture this: 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 that 180 day period, the QI held your relinquished property funds in an account earning interest. If the interest rate is 2 percent, then 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 will charge higher upfront fees, but take a lower percentage of interest income. Others QI’s 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.
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Other Fees
In addition to income interest and 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
- Become a member of RealWealth® to get access to a list of Qualified Intermediaries frequently used by our members. Click here to join for free.
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.
Conclusion
A Qualified Intermediary for a 1031 exchange plays a critical role in facilitating a successful exchange. Which is why it’s so important to compare several different QIs, their experience, services and fees, before moving forward with an agreement.
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 as a way to avoid paying capital gains taxes–at least until a later date.
