Internal Revenue Code 1031 allows for the deferral of gains on the sale of an asset when the gain is reinvested in a like-kind asset within 180 days. This transaction is called a 1031 exchange. For an exchange to be valid, the exchanger cannot have control over, or benefit from, the proceeds from the sale during the exchange period. This is usually accomplished by using a Qualified Intermediary (QI) who serves as the custodian of the proceeds until they are reinvested in like-kind property to complete the exchange. Not only does the QI have a critical role in meeting the compliance aspects of IRC 1031, but, as the custodian of the exchanger’s funds, it has the responsibility to ensure that these funds remain secure and available on the closing date of the exchange.
Surprisingly, more often than not, selecting a QI seems to be more of an afterthought. Common reasons cited for selecting a QI range from doing a Google search and choosing the lowest price from the first page, choosing the bank or title company involved in the transaction, or choosing based upon the recommendation of an acquaintance or neighbor. In other words, when it comes time to select their 1031 exchange QI, some exchangers may think, “What’s the big deal?”
The big deal happens to be that nearly $1 billion of exchange funds have been lost or stolen over the last decade due to mismanagement of funds from inexperienced or even unethical QIs. It turns out that some QIs aren’t completely transparent about where exchange funds are held, what funds movement controls are in place, or how the exchange funds are held. Unless you do proper due diligence on your QI, it could turn out that the QI referral you once trusted may invest your money in illiquid securities or run a Ponzi scheme. And before you know it, you could potentially lose millions of dollars if your exchange funds are not available in time to complete your exchange or you might lose those funds entirely.
So how should exchangers know what to look for in a QI? Section 1031 of the tax code is complex enough on its own, and with the lack of any federal guidelines in place, it can be difficult to distinguish disreputable practices from safe operating procedures. No one wants to lose money. Luckily, if you know what to look for, finding a good Qualified Intermediary can be relatively easy.
A good QI follows best practices by:
- Holding your money in a segregated escrow or trust account
- Only using dual control bank accounts preventing the QI from being able to move exchange funds without the exchanger’s approval
- Showing you where and how your money is being held at all times
- Having a dedicated staff with years of experience to prove their credibility
Selecting the right QI should always be a priority and never just an afterthought.
Find out more by checking out these 1031 Best Practices.
What is a 1031 exchange? Find out more by downloading our 1031 Exchange Kit.
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