Who Cannot Be Your 1031 Qualified Intermediary?

Your Qualified Intermediary cannot be a "disqualified person". In broad terms that means anyone who has acted as your agent in the two years before the sale, such as your employee, attorney, accountant, investment banker, broker or real estate agent, plus close family members and entities you or they substantially own. If a disqualified person holds your sale proceeds, the safe harbor that protects the exchange generally does not apply, and the exchange can fail even when every deadline is met.

Why does it matter who holds the exchange money?

A deferred 1031 exchange works because you never have access to the sale proceeds. The Treasury regulations create a safe harbor for this. If an independent Qualified Intermediary takes the proceeds at closing and uses them to buy your replacement property, you are not treated as having received the money.

The safe harbor only works if the intermediary is genuinely independent of you. If the person holding the funds is effectively your agent, the tax code looks through the arrangement and treats the money as yours. That is constructive receipt, and once it happens the exchange is generally over. Choosing the wrong intermediary is one of the few mistakes that can sink an exchange before it has really started.

Who counts as a disqualified person?

The regulations define the term in three main groups.

• ›Your agents. Anyone who has acted as your employee, attorney, accountant, investment banker or broker, or real estate agent or broker, within the two year lookback period.
• ›Your relatives and related entities. People and entities related to you under the tax code's related party rules, with a lower ownership threshold than usual. That includes your spouse, siblings, parents, grandparents, children and grandchildren, and companies or partnerships in which you hold more than 10 percent.
• ›People related to your agents. A firm or person related to one of your disqualified agents is generally disqualified too. Your accountant's own company, for example, usually cannot step in where the accountant could not.

The definition is deliberately broad. It is aimed at anyone who might reasonably be expected to follow your instructions about the money.

How does the two year lookback work?

The period runs back two years from the date you transfer the first property you are selling in the exchange. If someone acted as your agent at any point in those two years, they are generally disqualified, even if the work was small and unrelated to real estate.

Illustrative example only. Suppose an owner closes the sale of a rental on June 1. An attorney drafted a lease for that owner eighteen months earlier. Because the lease work falls inside the two years ending June 1, that attorney would generally be a disqualified person for this exchange. If the lease work had been done three years earlier, with nothing since, the result would usually be different.

The practical point is that the people you trust most are often the ones the rules exclude. A longtime CPA, a family member who handles your paperwork, or the broker who listed the property all tend to fall inside the definition.

Are there any exceptions?

Yes, two important ones.

Exchange services. Work done for you in connection with 1031 exchanges does not, on its own, make someone your agent. A Qualified Intermediary who handled your previous exchange is not disqualified simply because it served you last time.

Routine financial, title and escrow services. Routine services from a financial institution, title insurance company or escrow company are generally not treated as agency. Having a checking account at a bank, or having used a title company on an earlier purchase, does not by itself disqualify that institution or its exchange affiliate.

These exceptions are narrower than they sound. A title company that also gave you broader advice, or a bank employee who acted as your personal adviser, may be a different matter. Your CPA and attorney should look at the actual history.

Can my real estate agent or attorney be my intermediary?

Generally no. Your listing agent is your agent in the most direct sense, and most attorneys and accountants who have done any non exchange work for you in the last two years fall inside the definition.

They still have an important role. Your attorney can review the exchange agreement, your CPA can model the tax position, and your agent can coordinate the timing of the sale and purchase. What they cannot do is hold the money or act as the intermediary of record.

Can I use my own company or a family member?

No. A company you control, a trust you manage for your own benefit, or a relative who agrees to hold the funds will generally be treated as you or as a related party. The same problem arises if an intermediary is owned by someone in your family or by a business you own more than 10 percent of.

Owners sometimes propose this to save the intermediary fee. The saving is small compared with the tax that can become due if the exchange is disallowed.

What happens if a disqualified person was used?

If the intermediary turns out to be disqualified, the safe harbor generally does not apply. The likely result is that you are treated as having received the sale proceeds, and the sale may be taxed as an ordinary sale in the year it closed, including depreciation recapture and any state tax.

This is difficult to fix after the fact, because the problem exists from the moment the proceeds are paid out. That is why the question belongs before the sale contract closes, not after.

How do you check before you sign?

A few questions, asked early, cover most of the risk.

• ›Has this person or firm done any work for me, other than exchange work or routine banking, title or escrow, in the last two years?
• ›Is the intermediary owned or controlled by my CPA, attorney, agent, broker or a relative?
• ›Do I or any family member own an interest in the intermediary?
• ›Will the intermediary confirm in writing that it is not a disqualified person as to me?

It is also worth asking how the intermediary holds funds, whether accounts are segregated, and what bonding or insurance it carries. Independence and safety are separate questions, and both matter.

The short version

The intermediary has to be someone outside your own circle. Your agent, attorney, accountant, employee, close family and your own companies generally cannot fill the role, and the two year lookback catches more people than most owners expect. This article is general education, not tax or legal advice, and your CPA and Qualified Intermediary should confirm how the rules apply to your own situation before your sale closes.