Qualified Intermediaries (QI’s)

IRS regulations require that all proceeds of sale after closing on the relinquished property and before closing on the replacement property must be held by a qualified intermediary or safe harbor. The IRS requires that the taxpayer may not be in either actual or constructive receipt of the money. Prior to the closing of the relinquished property the taxpayer must enter into an “exchange agreement” with a qualified intermediary/safe harbor or the IRS will rule that the taxpayer was in “constructive” receipt of the proceeds of the sale and will disallow the tax-free exchange. In the event of an audit, one of the first items reviewed by the IRS will be the status of the QI/safe harbor. If the QI/safe harbor is not acceptable, serious tax consequences will follow as the capital gains tax will now be due with additional penalties and interest.

There are a multitude of individuals and corporations that can function as a safe harbor/QI. The most common QI’s used are:

1. Companies established to act as safe harbors, such as Investors Title Exchange Corporation, Lawyers Title Exchange and Starker Exchanges.
2. Any CPA as long as the CPA has not performed any work for the taxpayer for the past two years
3. Any attorney as long as the attorney has not performed any work for the taxpayer for the past two years.
4. Any trust department of any bank, as long as it has not been the bank of the taxpayer for the last two years.

The number one concern any investor should have in selecting their QI/safe harbor is the safety of their money. While individuals or companies may come highly recommended, it is best to insure that your money will be maintained in a separate account with the QI being bonded. The QI is not there to give tax advice. He or she normally communicates with the taxpayer indirectly by working with the CPA, personal attorney or closing attorney. The taxpayer may use the same QI two or more times in the same year.

The QI will provide guidance in insuring that all contracts to list the relinquished property, to sell the relinquished property and to purchase the replacement property will include the appropriate legal language to indicate that this is part of a properly executed 1031 tax exchange

An Exchange agreement must be entered into between the taxpayer and the QI before the closing of the relinquished property. This is a contract in which the taxpayer and the QI agree to a number of things including:

1. That the QI/safe harbor will act as a safe harbor
2. What the fee for service will be
3. That the taxpayer is executing a 1031 exchange
4. Whether the funds will be place into an interest bearing account and whether the taxpayer or the QI will received the generated interest
5. When the taxpayer can demand the funds
6. The termination of the exchange agreement
7. Liability issues
8. Additional legal paragraphs
9. A signature page

Having a QI/safe harbor in place prior to the closing of the relinquished property is critical because of the various documents that need to be signed prior to closing and to avoid the taxpayer having constructive receipt of the money.

There are three exhibits to the exchange agreement:

1. The Relinquished Property Description of all property to be sold as part of the 1031 exchange
2. IRS Form W-9 showing the taxpayer Social Security number of tax ID number
3. Replacement Property Identification Form if additional time may be necessary to close the purchase of replacement properties (remember, 45 days to identify and 180 days to close)

The QI will be “stepping into the shoes” of the taxpayer and will receive the proceeds of the sale of the relinquished property. The taxpayer will deed the property directly to the purchaser, however the purchaser, the QI and the taxpayer will all sign a Relinquished Property Assignment that will allow the QI to receive the proceeds of the sale, bypassing the taxpayer.

Similarly, the taxpayer, the QI and the seller of the replacement property will all sign a Replacement Property Assignment whereby the QI “steps into the shoes” of the taxpayer to fund the purchase of the replacement property, however the seller deeds the property directly to the taxpayer. Any mortgage needed to secure the purchase of the replacement property is solely the responsibility and obligation of the taxpayer.

The QI will send an Addendum to the Closing Statement to the closing attorney for signature by the taxpayer, the QI representative and the seller of the replacement property. This form states that the QI is involved in the transaction for 1031 purposes only.