As discussed in earlier posts, the 1031 exchange is a popular strategy used by agricultural landowners to sell farm property and defer paying capital gains tax. We have discussed many of the rules and guidelines that must be followed to execute a 1031 exchange successfully.
One of the most important exchange requirements is the use of a Qualified Intermediary, or QI, to facilitate an exchange. This post will help you know what to look for when selecting a QI.
What is a QI?
Every exchange requires a facilitator, or a QI, to complete the transaction. The QI is a person, company, or entity that holds the proceeds from the sale of your ag land in a trust or escrow account to ensure you never take receipt of the sale proceeds throughout the exchange process.
Who Can Serve as a QI?
1031 exchange rules stipulate that neither you nor a "disqualified person" can serve as a QI. A disqualified person is someone who has acted as your employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the two years preceding the date of the transfer of your relinquished (sold) property.
A QI has three key responsibilities:
- Preparing the 1031 exchange legal agreements and related transaction documents to structure the transaction properly.
- Receiving, holding, and safeguarding the 1031 exchange funds throughout the transaction.
- Advising, coordinating, or consulting on implementing the 1031 exchange transaction to ensure compliance with the Internal Revenue Code, Treasury Regulations, and related Revenue Rulings and Procedures.
What to look for in a QI
QIs are not licensed or regulated by any government agency, so it is essential to rigorously screen QIs to select one that has the necessary expertise, bonding, and procedures in place to execute a successful exchange. In particular, you will want to validate the QI's:
Confirm the QI has at least 10+ years of experience with 1031 exchanges. In addition, the QI should provide an extensive list of references that validate their track record of successful exchange transactions.
Policies, Procedures, and Internal Audit Controls
Confirm that the QI has detailed policies, procedures, and internal audit controls, including multiple checks and balances.
Separate, Segregated Qualified Trust Accounts
Confirm the QI segregates the funds for each exchange into separate accounts held distinctly for each exchanger's benefit.
Safety of 1031 Exchange Funds
Confirm that the QI maintains fidelity bonding from a reputable provider to transfer the risks of deliberate wrongful acts to another party.
Errors and Omissions Insurance
Confirm the QI maintains a current errors and omissions (E&O) insurance policy from a reputable provider to minimize risks associated with actual or perceived during the exchange period.
Request a copy of the QI's insurance policies, both E&O insurance and fidelity bonding, to verify the insurance underwriter, the policy limit, and the policy term and expiration date are sufficient.
It is also important regarding the fidelity bonding to note whether the policy limit is "per occurrence" (applicable to each insurable incident) or "in aggregate" (the total or maximum coverage available to investors per 12-month policy period regardless of the number of losses).
Our experience has shown that these five screening questions will help you quickly assess if a QI has the experience and knowledge needed for your exchange.
- How many years have you been facilitating 1031 exchange transactions?
- Do you hold a client's 1031 exchange funds in a segregated Qualified Trust Account or a Qualified Escrow Account?
- Do you maintain fidelity bond insurance coverage?
- Do you maintain sufficient errors and omissions (E&O) insurance coverage?
- What type of processes and internal audit controls have you implemented to protect my 1031 exchange assets?
Where to Start
How do you go about finding and interviewing QIs? A good place to start is by asking for references from your team of professionals (your attorney, tax accountant, financial advisor) you will be working with on your exchange.