Is your Intermediary qualified to be an exchange accommodator? How to determine a disqualified party?
Written By Diane Schaefer, CES™ and President of Exchange Solutions, Inc., N.Y.
The qualified intermediary (QI) is an essential part of a tax-deferred exchange. The agency relationship, constructive and actual receipt issues are resolved if the safe harbor requirements of using an intermediary are implemented. Under regulation section 1.1031(k)-1(g)(6), the qualified intermediary or accommodator, can not be an agent for the taxpayer. The regulations define a qualified intermediary as someone who is not the taxpayer, or a related party, and for a fee, facilitates the deferred exchange by entering into an agreement with the taxpayer for the exchange of the relinquished and replacement properties.
The accommodating party cannot be a “disqualified person.” A disqualified person is defined in IRC section 1.1031(k)-1(k)(2), (k)(3), or (k)(4). Two classifications of disqualified parties are: (1) A person who is the agent of the taxpayer at the time of the transaction. A person who has acted as the taxpayer’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker, within the two-year period ending on the date of the transfer of the first of the relinquished properties, is treated as an agent of taxpayer at time of the transaction. (2) A person who assumes a relationship with the taxpayer as described in IRC section 267(b) or section 707(b), (changing out “10%” to “50%,” each place ten appears). Combining these two sections, examples of disqualified parties are as follows:
• Family members (siblings, spouses, ancestors, and lineal descendants). • An individual and an entity (corporation or partnership) wherein the individual owns, directly or indirectly, 50% or more in value of that entity.
• Two entities in which the same individual owns, directly or indirectly, 50% or more of each.
• An estate in which the taxpayer is either the executor or beneficiary of the estate.
• A trust in which the taxpayer is the fiduciary and the related party is a beneficiary either of that same trust or a related trust or fiduciary of the related trust.
Entities that can qualify as exchange accommodators are financial institutions, title insurance companies, independent professional intermediaries and/or escrow companies.
Additionally, the safe harbor will be recognized only if there is an agreement between the taxpayer and the qualified intermediary that specifically limits the taxpayer’s rights to receive, pledge, borrow or otherwise obtain the benefits of money or other property held by the QI as provided in paragraph 1.1031(k)1(g)(6). One option to restrict the funds is to establish a qualified escrow account wherein the escrow holder is not the taxpayer or a disqualified party and the escrow is controlled by the accommodator (IRC section 1.1031[a]-3[g][3]). The regulations define a qualified escrow account and qualified trust as an account or a trust where the escrow holder is not the taxpayer or a related party and the taxpayer’s rights to receive the funds are restricted to specific circumstances (IRC Section 1.1031[a]-3[g][3][ii] and [iii]). This safe harbor terminates at the time the taxpayer has an immediate ability or unrestricted right to receive money or other property pursuant to the security or guarantee arrangement. The (g)(6) limitations are crucial to this safe harbor’s existence.
A deferred exchange may be easily structured using this safe harbor; however, the taxpayer must be cautious and observe the exchange equity restrictions and the related party rules (IRC Section 1.1031[a]-3[k]).
The use of a QI has become the prevalent method of handling deferred exchanges. Taxpayers have numerous choices of escrow companies, holding companies and qualified intermediaries. But before retaining a QI, taxpayers should carefully analyze the expertise as well as the financial stability of the entity providing this service. Taxpayers can seek out a host of certified exchange specialists (CES) from coast to coast by visiting the Federation of Exchange Accommodators site at www.1031.org.
