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How to Select a Qualified Intermediary

May 10, 2019

Choosing the right qualified intermediary to handle your 1031 exchange is an extremely important issue. A wrong move here can lead to the collapse and failure of a 1031 transaction. To successfully complete an exchange, taxpayers must do more than comply with the main paragraph of Section 1031. They also have to follow all of the other secondary rules which come from the Treasury Regulations. And if taxpayers attempt a so-called reverse exchange, they have to be mindful of the IRS guidelines on such transactions. Make no mistake. Section 1031 is a veritable minefield of rules. Following all of these rules and checking off all of the boxes are not easy tasks. Given the complexity of Section 1031, taxpayers need the services of a qualified intermediary with ample experience in this area.  

Qualified intermediaries serve two primary functions in the 1031 exchange process. First, they hold the funds from the sale of relinquished property to insulate taxpayers from constructive receipt. They also provide guidance to taxpayers so that all applicable rules are followed. If a taxpayer fails to comply with even one of the 1031 exchange rules, the result may be a failed transaction. That often results in a sizable bill which includes hefty capital gain taxes, interest and penalties. In this post, we will discuss several key things taxpayers should look for in a prospective intermediary. Given the stakes involved, it is critical that taxpayers take the time to carefully select the best intermediary. 

Successful Track Record 

As mentioned, qualified intermediaries hold exchange funds so that taxpayers avoid constructive or actual receipt during the exchange timeline. What’s more, they also help taxpayers understand and follow all of the rules which apply to 1031 transactions. For instance, they counsel taxpayers on the identification rules, which we’ve discussed before on our blog. They help taxpayers identify potential issues which could arise depending on the given facts of their situation.

For instance, if a taxpayer mentions that they’ve only owned their rental property for five months, and they’ve yet to actually find tenants for the property, a competent QI would then counsel them on whether they are likely to comply with the “holding requirement” of Section 1031. That requirement states that the property can only be held for investment or business purposes. One of the best ways to determine whether a given QI is adequate is to look at their track record. Have they handled a lot of transactions which have failed? How many transactions have they completed in total?  

Indicia of Poor Advice?

When a transaction fails, it’s not always the fault of the QI. In some cases, a taxpayer simply fails to comply with one of the rules which was already brought to his or her attention. A taxpayer may fail to complete his identification form, for instance, before the end of the 45 day deadline. Either way, if a QI shows a relatively high percentage of its transactions failing, this may be a good indicator of poor counsel on the part of that QI. You’ll also want to look at the sheer volume of transactions completed by the QI. More completed transactions mean more experience and therefore a good probability of greater familiarity with the rules and regulations. Again, this isn’t necessarily true in all cases, but it’s definitely something to look out for. 

Competent Staff 

Along with a good company track record, another thing to look for in a prospective qualified intermediary is competent staff. When you shop around for a QI, be sure to pay close attention to the personnel. Do they have good credentials? Have any of the staff produced publications related to Section 1031? If so, have those publications been reviewed by other industry professionals? Does the QI employ any in-house tax attorneys or CPAs? Sometimes, taxpayers browsing for a QI can be blinded by a lot of unfamiliar terminology and complex concepts. Often they fail to pick up on the things which indicate potentially subpar performance. 

When looking for a QI, you cannot rely just on what a given person says. Rather, you have to cut through the talk and look more closely at the person’s credentials, accomplishments and output. People who work with the tax code very often assume that whatever they say will be taken at face value. That’s because very few have both the ability and inclination to confirm or disprove a certain piece of counsel. Don’t fall into this trap. Go the extra mile and make absolutely sure that the staff of your QI knows what they are talking about. 

Bond Coverage & EO Insurance 

Because your QI will be holding your exchange proceeds for a period of time, you want to make sure that your QI has adequate financial safeguards. You will want to check carefully to be certain that a given QI has sufficient coverage for your specific transaction. Minimum levels of coverage and insurance vary by state. Accordingly, just because a QI meets the required minimum doesn’t mean that the level of coverage is sufficient for you. There are two types of coverage you will want to look for. The first is fidelity bond coverage. The second is errors and omissions insurance, also commonly called “E&O Insurance”. A fidelity bond provides insurance to the QI in the case of criminal behavior on the part of its employees. Fidelity bonds, therefore, impact the financial viability of a QI if there should ever be foul play by its employees.

Errors and omissions insurance, in contrast, provides insurance for QIs in the case of negligence by one of its employees. Again, this type of insurance should provide prospective clients with some level of security. That’s because the insurance will ensure that the QI is financially capable of providing relief in the case of employee negligence. 

Our NYC Tax Attorneys Can Help

At Mackay, Caswell & Callahan, P.C., we understand the complexity of Section 1031 and do our best to assist clients with these transactions. The key is to not be overwhelmed by the complexity of the process. It’s important to remember that there are competent professionals out there who can help you. If you’re contemplating a 1031 exchange and need assistance, or have another tax issue, reach out to us. Our New York City tax attorneys will review your case in double quick time! 

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