One of the key players of every valid 1031 exchange will be the qualified intermediary (often referred to as the “QI”). This is the individual who will hold proceeds from the sale of your relinquished property until you close on your replacement property. In the case of a reverse exchange, he or she will hold title to your new property while you sell your old property. This individual will also advise you along the way as to deadlines and filing requirements. As such, the person plays in invaluable role in ensuring your exchange goes smoothly and meets the strict IRS rules to ensure a valid exchange.
Despite the importance of this role, many investors are unclear on exactly what the QI does and, more importantly, how to select a competent individual for the role.
Who is the Qualified Intermediary?
When you are executing a 1031 exchange, you will usually require the services of a qualified intermediary (QI). Also known as an exchange accommodator or 1031 exchange facilitator, the role is the same – it is the neutral, disinterested third-party who will:
(a) Prepare the exchange legal agreements and related transaction paperwork so that the exchange is properly structured;
(b) Receive, hold and safeguard the 1031 exchange funds during the pendency of the transaction; and
(c) Advise you during the process to ensure your compliance with all IRS code, regulations and procedures.
Despite the importance of the qualified intermediary’s role, you may be surprised to learn that QIs are not required to be licensed, regulated, audited or otherwise monitored by any regulatory body. Likewise, they are normally not obligated to be bonded, insured or maintain any other safeguards for client protection.
Surprisingly, anyone can call themselves a qualified intermediary and start administering 1031 exchanges. This puts investors in a potentially risky position. Yet once you understand the key factors to scrutinize as you select your own QI, you will be in a strong position to select a QI who is competent and proven.
Due Diligence During the Selection Process
Now that you understand the true scope of the QI role, it is time to identify the key questions to ask as you perform due diligence. You should know the answers to all of the following before selecting your next QI.
1) What is the knowledge, expertise and experience of the qualified intermediary? The best way to safeguard against unexpected issues in a 1031 exchange is by partnering with a QI who has the technical depth, experience and knowledge to catch problems before they arise. Be sure to ask about the QI’s background and past 1031 exchange experience.
2) What internal policies, procedures and safeguards are in place? A competent and seasoned QI will welcome your inquiry as to the audit controls he or she has in place to ensure a smooth transaction. If you ask and are met with vague statements, it is a possible sign that the QI is not as detail-oriented as necessary to ensure a streamlined process.
3) Does the QI maintain separate, segregated qualified trust or escrow accounts? A responsible QI will keep all client funds clearly separate from his or her own funds at all times. The safest way is by using dedicated trust or escrow accounts for all client funds.
4) Is the QI bonded and insured? Given the reality that your QI will hold a significant amount of your money for a potentially lengthy amount of time, you want to make sure that your assets are protected against catastrophic loss. To best safeguard your resources, ensure that your QI is both bonded and insured, and ask to know about his or her claims record, too, for good measure.
5) Does the QI have Errors & Omissions Insurance? At the end of the day, qualified intermediaries are only human and human beings make the occasional mistake. Be sure to understand if your potential QI has appropriate insurance in place to safeguard against mistakes during the 1031 exchange process.
While not even the most stringent due diligence process can promise 100% safety, you will be much further ahead if you take the time to ask prudent questions before selecting your next qualified intermediary.