As you are rushing to decide on the sale of your property, one of the things that most people think about is selecting a qualified intermediary, also known as “QI” (a.k.a.” exchange accommodator” (also known as “facilitator”). In the end, aren’t they precisely the same? Aren’t all intermediaries who are qualified “qualified”? Yes, not necessarily.
This guide on choosing an intermediary certified for 1031 will provide you with seven critical questions to inquire about before selecting one for your exchange. Armed with these seven essential questions, you’ll be able to engage in a brief conversation with the 1031 facilitator you are contemplating.
Background: The Most Qualified Intermediaries Aren’t Regulated.
In contrast to banks, stockbrokers, or insurance corporations, there’s no standard for national or federal oversight of qualified intermediaries. In most states, QIs aren’t required to be licensed or insured/bonded; however, the IRS requires an approved intermediary to store your 1031 exchange money!
What is the significance of this? In 2012 The Federal Trade Commission reported that it had information on 23 instances where investors suffered losses of approximately $250 million due to fraud or incompetence of qualified intermediaries. Although such cases are sporadic, remember that you trust an accommodator with your hard-earned gains from selling your home. This requires much confidence.
It is crucial to work with a reputable intermediary that could be the difference in an effortless 1031 exchange or the worst nightmare (no overstatement).
In general terms, the term “QI” refers the term “QI” is used to describe a QI can be described as a QI that performs three types of work:
- It makes the legal documents necessary to structure an appropriate 1031 exchange.
- Protects and holds the money you earn from selling your property (i.e., your 1031 profits) until you have closed on a new property.
- Check that your exchange conforms with the rules of the Internal Revenue Service.
A qualified intermediary (QI) is required to facilitate the 1031 exchange. The QI is an individual with funds from the sold property and uses them to purchase the replacement property. The funds do not come in contact with the property’s owner, who is affected by 1031 according to the IRS 1031 regulations.
As I said, QIs aren’t regulated. Finding a quality QI is an exercise in studying the knowledge and experience of different QIs. Even if a QI has been mentioned to you via or through word or word of mouth, it’s wise to conduct your research about each QI you’re interested in. One source that may be of help can be the Federation of Exchange Accommodators, which is a trade organization for QIs.
The QIs job is to complete the facilitation of exchanges in 1031. One of the first steps in dealing with QIs is to sign an agreement. Once the contract is signed and signed, the QI can proceed by completing the exchange of 1031. That means they’ll be accountable for every aspect of the transfer and acquisition of real estate between the buyers and seller and handling the funds. They must also ensure that the QI is responsible for ensuring that the taxpayer is granted limited ability to access the money, such as borrowing, pledging, or gaining any benefit from the property or funds when they are under the QIs supervision.
Who is qualified to become QI? Anyone can be a QI. To determine who is QI, it is necessary to examine who isn’t QI. A QI is a person who is not an exchanger or disqualified. You may be wondering what qualifies as an individual who is disqualified?
The same rules define a person disqualified as anyone who has served as the exchanger’s agent for two years before the date of transfer for the property being relinquished. An agent could be one of these:
- Exchangor’s employee
- A broker or investment banker
- Real estate broker or agent
A Cautionary Story: Lam Exchange Services Bankruptcy
The world of qualified intermediaries was under scrutiny on Friday, November 26th, if LandAmerica 1031 Exchange Services (LES) applied to protect its bankruptcies. LES had been a significant player in the qualifier intermediary market. In reality, LandAmerica Financial Group, the parent company of LES, was the third-largest title insurance provider in the nation.
When LES was declared bankrupt, the company was an exchange accommodator for more than 450 individual investors, holding the sum of $420 million in their exchange funds from 1031. About 400 had signed an agreement that did not require a “segregated account,” likely because they didn’t realize the risks of selecting the less expensive option of placing their money into a single “commingled account.” The combination account option was less costly since LES was legally permitted to invest investors’ money and retain most of the profits. The financial crisis struck in September of 2008. The values of the bonds LES was investing in fell by over 50%, making LES insolvent, and forcing the company to file for bankruptcy.
It took over five years before investors who could not access their funds through bankruptcy could recover their money, per an official statement from Gerard A. McHale Jr., the Bankruptcy Trustee for LES.
7 Question To Consider Before Selecting An Accommodator For 1031
Question 1: How Many Years Has The Qualified Intermediary Known As The Business?
In general, the longer a QI’s been in the business, the longer they’ve been in business. It signifies that they know about dealing with exchanges and understand the laws and regulations that regulate the exchanges.
Question 2: What Number Of Exchanges Did A QI Complete Over The Last Five Years? What Is The Aggregate Dollar Value Of Exchanges In Each Of These Years?
Dividing the dollar amount yearly by the number of exchanges gets an average. Hopefully, this will not be substantially less than the amount you need to exchange.
Questions 3: What Is The Percentage At Which QI’s Business Is Traditional Forward Or Delayed Exchanges In Contrast To More Complex Sorts, Such As Reverse Or Enhancement Exchanges?
There’s no definitive answer to this question; however, a company that regularly executes more complicated exchanges could have better technical proficiency. Another indicator of proficiency is the credentials that are held by those CPAs and tax lawyers they employ. Many firms perform these services within their departments. Basic QI services don’t offer tax advice. However, these services can be precious in the event of an issue with taxes.
Question 4: What Will My Money Be Managing?
Your money is recommended to be kept in a Separate Qualified Trust Account or Segregated Qualification Escrow Account. Beware of the low-cost alternative of a commingled account and QIs that promise the highest interest rate.
Question 5: What Happens To My Funds? Be Located?
The most effective solution is to ensure that the 1031 money will be kept at a large reliable, well-known FDIC-covered bank. Be aware that FDIC insurance is typically restricted to $250,000 per account holder. If you are worried about the health of the bank where the QI is holding the funds, you may request that an alternative bank control them.
Question 6: May I Get A Written Copy Of Your Internal Controls?
Internal control is the guidelines and procedures designed to protect your funds from fraud or theft committed by company employees. Knowing the approvals, oversights, and techniques required to transfer or release your funds is essential. Each employee shouldn’t have the authority to do this. The best practice is to have your signature and then multiple written authorizations within the QI’s organization, making it hard for any of your employees to access your money. In addition, at minimum, the QI should be conducting regular background checks for every employee. Don’t be afraid that reputable companies take their fiduciary responsibilities seriously and will happily offer you the details of their internal controls. You should be extremely cautious if they don’t take their responsibility seriously.
Question 7: What Types And Sizes Of Insurance Do They Have?
The insurance coverage offered by QI guards against theft of your funds and/or if the IRS declares that you must pay tax because of the company’s negligence. At a minimum, your account should be secured through fidelity bond coverage and errors & Omissions (E&O) insurance. In addition, how do your fidelity bond and E&O insurance coverage stack up to QI’s average of 1031 deposits for all of their exchangers? To calculate QI’s typical 1031 deposits, divide the total value of exchanges through Question 2.
For example, suppose that a QI made 240,000 million in exchanges in the past two years. If we assume that a QI keeps the money for exchanges for 120 hours (120/365 equals 3), Their average of 1031 deposit funds is the sum of $80million ($240M/3). There’s no absolute rule; however, if a QI holds a $1 million fidelity bond and $250,000 of E&O insurance, it’s not much protection against the amount of $80 million.
The Exchange Agreement With A Qualified Intermediary – Read It!
After you’ve conducted your due diligence with respect to the QI, you should read your Exchange Agreement (and have your attorney go over it). This Exchange Agreement is the contract between you and the QI which regulates the relationship. It should be in accordance with what you’ve learned in the due diligence process. If you find an inconsistency, you should raise the issue before signing the Exchange Agreement.
You’ve Decided On Your Qualified Intermediary. Now What?
Before we go into what happens when you have chosen a QI, an important point to remember is that the best time to select a QI is to pick your QI before the property transfer. It is best to have a QI involved at the earliest time possible.
With the QI in place, exchange 1031 officially commences when the exchanger signs the contract documents using the QI. Completion of these documents is required before the end of the relinquished property. If they do not, the exchanger could discover that they are involved in a taxable sale, not an exchange under the 1031 law. When the exchange process is going on, the exchanger and his agent should avoid contact with the proceeds of the sale. The proceeds must be given to the buyer or closing agent, who will transfer them to QI. Documents related to the transaction should be sent to the QI before acquiring new property. Finally, the QI must submit these documents before closing the new property.
There are also essential deadlines to bear in mind when purchasing the property replacement. The property must be purchased within the first day of:
- 180 days after the date of transfer of the property to be sold.
- Tax return of the taxpayer due date within the year the asset was sold (inclusive for all extensions). It is important to note that there are no extensions on weekends or holidays.
While I’ve discussed several possible scenarios, My primary goal is to give you the information needed for making an educated choice on the QI you pick in your exchange 1031.
I’ve dealt with many QIs during the last 25 years; it is possible to confidently state that most QIs are responsible, honest, and trustworthy trustees of their fiduciary obligations to the exchanger exceptionally seriously. In that regard, I’m confident that the investors who fell victim to LandAmerica 1031 Exchange Services’ bankruptcy, as well as the other misconduct of QIs, would have been much better off had they adhered to a systematic process similar to the one I’ve mentioned above.