A 1031 Exchange company can play many roles in the 1031 process. However, not all roles can be performed at the same time for a client.
A 1031 exchange company can help guide an investor through the 1031 exchange process, they can help find 1031 exchange properties or they can act as an independent 1031 exchange intermediary.
Tell Me More About 1031’s
The main role of the 1031 exchange is to help Real Estate Investors defer taxes on qualified like-kind real estate property. The advantage is it allows the investor to grow their net worth over time. This is an excellent opportunity to prevent taxes slowing the investment growth momentum as the investor exchanges and trades-up for new properties.
What is a 1031 Exchange?
Before we get too deep into finding a 1031 exchange company, lets start off with what most people need to know the steps for a 1031 exchange.
The following are 8 stand steps of a 1031 exchange:
- First, sell your investment property.
- Then, give the capital gains to a qualified intermediary.
- Identify a like-kind property within 45 days of sale.
- Send a duty letter to your qualified intermediary.
- Negotiate with the seller of the property.
- Agree on a sale price.
- Have your intermediary wire the capital gains to the titleholder or title company.
- Lastly, Fill out IRS Form 8824. The link takes you to the form.
You Need a Qualified Intermediary For The Execution of the 1031 Exchange
As I mentioned, you can hire a 1031 exchange company. However, it’s not required that you hire a company. An independent person can qualify as an Intermediary.
A 1031 financial transaction begins with the proceeds of the sale of the old property, which must go through the hands of what’s termed a qualified intermediary.
The qualified intermediary holds all the profits from the sale until it’s necessary to disburse the funds at the closing of the exchanged property. In order to be qualified, the entire amount of the cash proceeds from the original sale must be reinvested in new real estate property.
It’s important to note that any cash kept by the investor from the sale of the old property is taxable income and must be reported to the IRS.
At the close of the relinquished property sale, the proceeds are sent by the title company handling the closing directly to the qualified intermediary. This, company, firm or person holds the funds until the transaction for the replacement property acquisition is ready to close.
Next, the proceeds from the sale of the old property are deposited by the qualified intermediary to purchase the replacement property. After the acquisition of the replacement property closes, the qualified intermediary delivers the property to the taxpayer, all without the taxpayer ever having what the IRS calls constructive receipt of the funds.
What makes the intermediary “qualified?
According to the IRS it’s because they are an independent party with the sole purpose to facilitate the 1031 exchange process. The investor can not act as their own facilitator. And the agent, that includes your real estate agent, investment broker, accountant, attorney, employee or anyone who has worked for the investor in those capacities within the previous two years. They cannot act as the investor intermediary.
The Properties Must Be Like-Kind to Qualify For 1031.
IRC Section 1031 allows you to postpone paying tax on gains only if you reinvest the proceeds in a similar or like-kind property. Like-kind property is a property of the same nature, character or class. It’s not as complicated as it sounds. Most real estate is like-kind to other similar real estate. However, there are some exceptions. A common example is real estate property located within the U.S. is not like-kind to property outside of The United States.
Real property and personal property can qualify as exchange properties under IRS Section 1031. Thou, real property can never be like-kind to personal property.
Here are two important rules as it applies to like-kind properties
- The total purchase price of the replacement like-kind property must be equal to or greater than the total net sales price of the relinquished property.
- All the equity received from the sale of the relinquished property must be used to acquire the replacement, like kind property.
Taxpayers who hold real estate as inventory or who purchase real estate for resale, are considered dealers. These properties are not eligible for Section 1031 treatment. However, if a taxpayer is a dealer and also an investor, they can use Section 1031 on qualified properties. Property for personal use will not qualify for Section 1031.
What To Look For In A 1031 Exchange Qualified Intermediary
When you look for companies to help you with a 1031 exchange, you are usually looking for a Qualified Intermediary.
Closing on a property can be stressful. You many not be thinking about selecting a qualified intermediary, – A.K.A known as an “QI” or an exchange “accommodator” or “facilitator”). The fact is you want to begin your search well before you need one.
The following is a list of ideas which can help you chose a 1031 qualified intermediary which will provide you with questions to consider and ask before selecting one for your 1031 exchange.B
Unlike many financial firms or companies such as stockbrokers or insurance companies, there is no national standard or federal supervision over qualified intermediaries. In Michigan, qualified intermediaries are not required to be licensed, bonded or insured, despite the fact the IRS requires a qualified intermediary to hold your 1031 exchange funds.
Questions to Ask Before Choosing a 1031 Qualified Intermediary
How Long Have You Been In Business?
The fact is, the longer the qualified intermediary has been in business, the safer for the investor. This is because the qualified intermediary has experience handling exchanges, faced unique situations and most likely a good understanding of the laws and regulations that govern them.
It is a good idea to insist your funds be held in a Segregated Qualified Trust Account or a Segregated Qualified Escrow Account. Try to avoid low-cost account options and qualified intermediaries which promise to pay a high-interest rate.
Investors want their funds safe and secure. 1031 monies kept in a large, reputable FDIC insured bank is the safest option. Don’t forget the FDIC insurance is limited to $250,000 per account holder.
Can I have a written copy of your internal controls?
Internal controls are the qualified intermediary’s policies and procedures that protect your funds against theft or fraud by the firm’s employees. This is important because it’s your money at risk. The idea is to understand the oversight, and steps required to move or release your money.
The fact is, no single employee should have sole authority. Best practices are to require your signature, followed by multiple written approvals within the qualified intermediaries organization. This makes it difficult for any one or two employees to access your funds inappropriately.
Lastly, the qualified intermediary should do a complete regular background check on all its employees. Reputable firms take their fiduciary responsibility seriously and will happily provide you with a copy of their internal controls.
Ask what types and amounts of insurance does the firm carry?
A qualified intermediary insurance coverage protects the investor against and their money from being stolen. It can also cover you if the IRS says you have to pay taxes, as a result of the companies negligence. At a minimum, your account should be protected by fidelity bond coverage and Errors & Omissions (E&O) insurance.
Please do not consider this article as professional financial advice. Use the article for general education as part of your due diligence before investing money.