Working With a Qualified Intermediary (QI): Timeline, Documents and What Each Party Does

The QI must be independent of you, and the two-year look-back rules out your usual advisers

Reg. section 1.1031(k)-1(g)(4)(iii) defines a qualified intermediary as a person who is not the taxpayer or a disqualified person and who enters into a written exchange agreement to acquire and transfer both properties. Paragraph (k)(2) treats as your agent anyone who acted as your "employee, attorney, accountant, investment banker or broker, or real estate agent or broker" within the two years ending on the date you transfer the first relinquished property.

Services limited to section 1031 exchanges, and routine title, escrow or financial services, are carved out, but a CPA who prepared your return last year or the agent listing the property cannot hold your money. Related persons are disqualified too. Whether an attorney, CPA or agent can be your QI works through the edge cases, and how to choose a qualified intermediary covers safeguards for the funds.

The regulations do not license or bond intermediaries, so the protections are the ones you negotiate: a segregated account in your name, dual-signature wires and written confirmation of who holds the money. See what happens if a QI goes bankrupt.

Before the sale closes: the exchange agreement, the assignment and the notice to the buyer

The exchange agreement must expressly say you have no right to "receive, pledge, borrow, or otherwise obtain the benefits" of the money before the exchange period ends, with only the exceptions in paragraph (g)(6): after day 45 if you identified nothing, after you receive everything you identified, or after a written contingency beyond your control. An agreement that lets you call for the money on demand fails the safe harbor from day one.

The QI does not normally take title. Paragraph (g)(4)(v) treats the QI as entering your sale contract if your rights are assigned to it and "all parties to that agreement are notified in writing of the assignment on or before the date of the relevant transfer." The buyer usually signs an acknowledgment, and your contract should carry a cooperation clause.

Open the exchange several days before closing so the closing agent has the QI's wire instructions; what the QI needs to open an exchange lists the information requested.

Closing day on the sale: the buyer's money goes to the QI, not to you

The closing agent wires the net proceeds directly to the QI's account. The regulation's own example has the buyer pay $10,000 to the seller and $90,000 to the intermediary; the $10,000 is cash received and taxable as boot, while the $90,000 stays protected. If proceeds reach your account first, see what happens when the buyer wires the title company instead of the QI.

Paragraph (g)(7) lets ordinary closing items pass without breaking the safe harbor: prorated rents and "transactional items" that appear on a typical closing statement, such as commissions, prorated taxes, recording or transfer taxes and title fees. Paying off your mortgage at closing is normal; paying personal bills is not.

The person responsible for closing usually files Form 1099-S for the sale. Its instructions provide a checkbox in box 6 when the seller received or will receive property other than cash as part of the consideration.

Days 1 to 180: identification, purchase assignments and the wires

Identification is your document, not the QI's. Under paragraph (c)(2) it must be in writing, signed by you and sent before midnight on day 45 to the replacement seller or to any person involved in the exchange other than you or a disqualified person; the QI is the usual recipient and should confirm receipt in writing.

For each purchase, you sign the contract, assign it to the QI and notify the seller in writing before closing. Paragraph (g)(4)(iv)(C) lets the deed go directly from the seller to you. You then send written funding instructions and the QI wires the exchange funds to the closing agent; any money you add comes from you directly.

When the last identified property closes, or the period ends, the QI releases any balance under the (g)(6) terms. That cash is boot in the year you receive it.

• You: sign the exchange agreement, assignments and identification; approve closing statements; add any extra cash; file Form 8824.
• QI: drafts the agreement and assignments, sends notices, receives and holds proceeds, wires purchase funds, reports interest and returns any balance.
• Closing agent: wires proceeds to the QI, prepares settlement statements, files Form 1099-S.
• CPA or attorney: reviews the agreement, the identification and the closing statements, and prepares the return.

After the exchange: interest, the year-end statement and Form 8824

Reg. section 1.468B-6 decides who is taxed on interest earned while the QI holds your money. If the agreement pays you all the earnings, for example from a separately identified account in your name, you report them; if not, the funds are treated as a loan to the QI and the QI reports the income. Either way the payor follows the normal information reporting rules, so expect a Form 1099 if interest is paid to you. Interest on exchange funds covers the boot question.

Keep the exchange agreement, assignments, notices, identification, both closing statements and the QI's final accounting. Your preparer needs them for Form 8824, which you file with the return for the year you transferred the relinquished property, and for two more years if the exchange involved a related party.

QI fees appear on the closing statements and are generally exchange expenses. Exchange fees: deductible or basis explains how they are reported.