You’ve decided to trade one investment property for another in a 1031 exchange. Can you do the work by yourself? The short answer is no. A 1031 exchange intermediary is required, and choosing the right person to help you is critical.
What Is a 1031 Exchange?
A 1031 exchange is a coordinated transaction involving two investment properties. One is sold, and another is purchased with the proceeds. The tax obligations associated with the sale are rolled into the new property, providing deep savings.
Experts say the vast majority of 1031 exchange transactions involve small properties. The real estate market remains fluid because investors are encouraged to place properties on the market when they sell them. Removing this tax break could encourage investors to keep their properties longer, which could make finding an investment harder for those new to the market.
While most investments are small, some are much larger. For example, an investor in Arkansas used a 1031 exchange to purchase a commercial building for $5.4 million. With so much money on the line, it’s smart to assemble a team of experts.
What Is a 1031 Exchange Intermediary?
While a 1031 exchange offers many benefits, it’s also associated with several rules. One of them involves a 1031 exchange intermediary.
Per IRS rules, investors can’t control the proceeds of a 1031 exchange before the entire transaction is complete. In other words, you can’t accept funds from the sale of your property into a business bank account. Doing so could make the entire sale a taxable event.
To avoid this outcome, you must hire a 1031 exchange intermediary who will hold the proceeds (or a property) for you while the rest of the transaction moves forward. With this expert’s help, you can get the tax benefits that make exchanges so attractive. If you skip this step, your entire transaction is in jeopardy.
5 Key Steps Performed by 1031 Exchange Intermediaries
When most people think about qualified intermediaries, they focus on the holding aspect. While it’s true that these professionals hold funds or property during an exchange, their responsibilities go much deeper. Here’s what they can do:
1. Prepare Legal Agreements
A qualified intermediary must be legally separated from you and your business, and the funds must be placed in an account that the investor can’t access directly. This legal safe harbor is a key part of an exchange, and it must be clearly documented in case the IRS comes knocking. A qualified intermediary can draw up the proper documents and ensure the setup is conducted by the book.
2. Hold Part of Your Exchange
In a traditional 1031 exchange, a qualified intermediary holds the funds from the sale of your property until it’s time for the purchase of the replacement version. In a reverse 1031 exchange, the intermediary holds (or “parks”) the property you purchase until you sell another as a replacement.
3. Accept Your Notification
Per IRS rules, you’re required to notify a qualified intermediary at key points in the transaction. Crucially, you must provide this authority with a written document that outlines the property you want to buy (in a traditional exchange) or the one you want to sell (in a reverse exchange).
4. Release the Item Legally
Per IRS rules, you’re required to complete the transaction within 180 days. At that point, your intermediary must release the funds for the purchase (in a traditional exchange) or the documents for the item you bought (in a reverse exchange).
These transactions are delicate, and they involve a significant amount of paperwork. At the end of them, the account opened for you should be legally closed. A qualified intermediary should keep you apprised of every step and ensure you know exactly what’s happening.
5. Prepare Tax Documents
The tax obligations associated with a 1031 exchange are deferred. The IRS requires investors to complete complex documents like Form 8824 to report the amount of gain deferred in the exchange. A 1031 exchange intermediary should complete these documents and ensure they’re filed properly.
How to Choose a 1031 Exchange Intermediary
The IRS has clear rules about who cannot be an intermediary. For example, you can’t perform this role yourself, and you can’t hire someone who has worked as your real estate agent, accountant, attorney, or employee within the prior two years. However, the IRS doesn’t outline what makes a good intermediary.
Before you choose someone to perform this important role, ask important questions like the following:
How many 1031 exchanges have you facilitated in the past?
How long have you been in business?
What types of transactions have you handled?
Do you have any relevant designations or certifications?
What are your fees, and what’s included in them?
How do you safeguard client funds?
Can you provide references from several of your past clients?
Take your time to find the right person to help with your 1031 exchange intermediary. Don’t be impulsive, and ensure you ask the right questions and get the answers you need. You shouldn’t rush into this decision, as you want to ensure you choose a qualified partner for your 1031 exchange intermediary.
Why You Should Choose 1031 Pros
At 1031 Pros, we provide a streamlined process that includes security measures that can protect your financial interests. We focus exclusively on 1031 exchanges—this is all we do. We use an insured individual account for each transaction, and we offer full transparency on every exchange. You can’t find anyone better to assist you with this process. Contact us to find out more and get started today.
References
Why the Attack on 1031 Exchanges is Likely to Fail (Again). (June 2024). Kiplinger.
Real Deals: Fayetteville Walgreens Sells in 1031 Exchange. (March 2024). Talk Business and Politics.
Like-Kind Exchanges Under IRC Section 1031. (February 2008). Internal Revenue Service.
Instructions for Form 8824 (2023). Internal Revenue Service.
Selecting a Qualified Intermediary for a Like-Kind Exchange. (October 2016). The CPA Journal: The Voice of the Profession.
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