Qualified Intermediary: What They Do and How to Vet One
A qualified intermediary is the party that holds your sale proceeds so that you never do. Engaging one is not paperwork. It is the structural condition that makes a deferred exchange work, it has to happen before the property you are selling closes, and it is the step at which more exchanges are lost than at any other.
What the intermediary actually does
The problem a 1031 exchange has to solve is that you are selling one property and buying another, but if the sale proceeds ever touch you, you have had a taxable sale followed by an unrelated purchase. The intermediary is the mechanism that keeps the two transactions as one exchange:
- You sign an exchange agreement with the intermediary before the relinquished property closes.
- The intermediary takes assignment of your rights in the sale contract, and the buyer is notified.
- At closing, the proceeds are wired to the intermediary, not to you and not to your attorney.
- The intermediary holds the funds under an agreement that restricts your access to them.
- When you identify and close on replacement property, the intermediary sends the funds directly to that closing.
- Any funds left over at the end of the exchange period are released to you, and that remainder is taxable boot.
Treasury Regulation 1.1031(k)-1(g)(4) is the safe harbor that makes this work: use a qualified intermediary under a conforming agreement, and you are not treated as having received the proceeds even though the sale closed.
The mistake that ends exchanges: closing first
An exchange has to be set up before the relinquished property closes. Once the escrow disburses to you, the money has been received and nothing done afterward reverses it. There is no retroactive appointment of an intermediary, no corrective wire, no cure. The sale becomes a taxable sale.
This happens constantly because nobody in a normal closing has the job of raising it. The listing agent is closing a sale. The escrow officer is following instructions. The buyer does not care. If you intend to exchange, you have to say so early and get the intermediary in place yourself, and then start counting the 45 and 180 day clocks from that closing date.
Who cannot be your intermediary
The natural instinct is to hand this to a professional you already trust. That is precisely what Treasury Regulation 1.1031(k)-1(k) forbids. The following are disqualified persons and cannot serve:
- Your employee.
- Your attorney, if they have acted as your attorney within the two-year period ending on the date you transfer the relinquished property.
- Your accountant or CPA, on the same two-year test.
- Your investment banker or broker, on the same two-year test.
- Your real estate agent or broker, on the same two-year test.
- A person related to you under IRC 267(b) or 707(b), which sweeps in family members and entities you control.
The two-year lookback runs backward from the date you transfer the relinquished property. A CPA who prepared your return three years ago and has not worked for you since falls outside it. One who prepared it last year does not. When in doubt, use an unrelated firm; the cost of an independent intermediary is trivial next to the cost of a failed exchange.
Constructive receipt, and why the agreement wording matters
You do not have to physically hold the money to be treated as having received it. If the funds are credited to you, set apart for you, or simply available for you to draw on, that is constructive receipt and the exchange fails. Treasury Regulation 1.1031(k)-1(g)(6) is the operative limitation: the exchange agreement must expressly restrict your right to receive, pledge, borrow against, or otherwise obtain the benefit of the funds during the exchange period.
Read that clause before you sign. It is short, it is standard in a competent agreement, and its absence is a serious problem rather than a drafting nicety.
Nobody licenses these firms
There is no federal licensing, registration or examination requirement for qualified intermediaries. There is no regulator that vets one before it opens, and no capital requirement. A firm holding several hundred million dollars of other people's exchange proceeds may be doing so with no supervision at all.
A minority of states regulate exchange facilitators, and California is one of them. California law imposes bonding or equivalent security requirements, insurance requirements, and prudent-investor standards on how funds are held, together with notification duties on a change of control. If you are exchanging California property, ask the intermediary directly whether they are subject to the California requirements and what they carry to satisfy them. Confirm the current requirements with your own counsel, as the thresholds are set by statute and can be amended.
Six questions to ask before you wire
How are client funds held?
Ask whether your proceeds sit in a segregated, qualified escrow or trust account in your name, or are pooled with other clients' money in a single commingled account. Segregated is materially safer. Ask for the account structure in writing, not a verbal assurance.
What bonding and insurance are in place?
Ask for the fidelity bond amount, the errors and omissions policy limit, and whether the bond covers the full balance the intermediary holds at peak. A one million dollar bond against a hundred million dollar book is not meaningful coverage of your particular exchange.
Who signs off on a disbursement?
Ask what controls exist before money leaves the account, and whether a single person can initiate and approve a wire. Dual authorization is the control that prevents both fraud and a successful wire-fraud email.
Are you regulated in California?
California is one of the few states that regulates exchange facilitators. Ask directly whether they are subject to it and what they carry to satisfy it.
How long have you been doing this, and through what?
Ask how long the firm has operated and whether it operated through 2008 to 2010, when several intermediaries failed. Longevity through a credit cycle is more informative than volume.
What does the exchange agreement actually restrict?
Ask to read the exchange agreement before you sign anything with the buyer of your property. It must expressly limit your right to receive, pledge, borrow against or otherwise obtain the benefit of the funds. If it does not, the safe harbor does not apply.
One more, which is operational rather than institutional: confirm every wire instruction by phone, to a number you looked up yourself and not one printed in the email. Real estate closings are the most heavily targeted transactions in business email compromise, and an exchange wire is a single large transfer to a party the sender has never met.
Where the intermediary fits with a DST
The intermediary's role does not change when the replacement property is a Delaware Statutory Trust. The proceeds still go to the intermediary at the sale closing, and the intermediary still sends them directly to the DST closing when you subscribe. What does change is timing: a DST closing is generally faster and more predictable than a direct purchase, because there is no negotiation, no financing contingency and no inspection period, which is one reason a DST is often used as a backup identification against a slipping deadline.
Qualified intermediary questions, answered
What does a qualified intermediary do?
A qualified intermediary is an independent party that takes assignment of your sale contract, receives the proceeds from the closing so that you never do, holds them, and then uses them to acquire the replacement property you identify. The intermediary exists so that you never have actual or constructive receipt of the money, which is the condition that keeps the exchange from being treated as a taxable sale.
Is a qualified intermediary legally required for a 1031 exchange?
A deferred exchange is not required by statute to use one, but in practice it is. Treasury Regulation 1.1031(k)-1(g)(4) creates a safe harbor under which the use of a qualified intermediary means you are not treated as having received the proceeds. Without that safe harbor, a deferred exchange is very difficult to defend. Every practical deferred exchange uses a qualified intermediary.
Can my own attorney or CPA be my qualified intermediary?
No. Treasury Regulation 1.1031(k)-1(k) disqualifies your agent, and defines agent to include anyone who has acted as your employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the two-year period ending on the date you transfer the relinquished property. Using a disqualified person voids the safe harbor and the exchange fails.
When do I have to engage the qualified intermediary?
Before the relinquished property closes. This is the single most common way an exchange is lost. Once the closing funds are disbursed to you, or to your attorney, or into your own account, you have received them and no intermediary engaged afterward can undo that. If the property has already closed and the money has moved, the exchange is generally over.
What is constructive receipt?
Constructive receipt means the money was made available to you even if you did not physically take it. If the funds are credited to your account, set apart for you, or otherwise available for you to draw on, you are treated as having received them. This is why the exchange agreement must expressly restrict your right to receive, pledge, borrow against or otherwise obtain the benefit of the funds during the exchange period.
Are qualified intermediaries licensed or regulated?
There is no federal licensing or registration requirement for qualified intermediaries. Anyone can hold themselves out as one. A minority of states, California among them, regulate exchange facilitators and impose bonding, insurance and prudent-investor requirements. In most of the country, the only protection is the diligence you do yourself before you wire.
What happens if the qualified intermediary fails while holding my money?
You are an unsecured creditor of the intermediary for funds held in a commingled account, and you also have an exchange running against a hard deadline that will not be extended for the failure. Several intermediaries failed during the 2008 to 2010 period and taxpayers lost both the money and the deferral. This is why the custody question, segregated or commingled, is the first one to ask.
Can I change qualified intermediaries in the middle of an exchange?
It is possible but it is complicated, and it introduces risk to the safe harbor at exactly the moment you can least afford it. The practical answer is to do the diligence before the relinquished property closes, because that is when you still have leverage and time.
Sources
- Treasury Regulation 1.1031(k)-1(g)(4), the qualified intermediary safe harbor.
- Treasury Regulation 1.1031(k)-1(g)(6), limitations on the taxpayer's right to receive funds.
- Treasury Regulation 1.1031(k)-1(k), the disqualified person definition and the two-year lookback.
- Internal Revenue Code Sections 1031, 267(b) and 707(b).
- California Financial Code, Division 20, on exchange facilitators.
This page is general information about tax law and transaction mechanics, not tax or legal advice, and nothing here is a recommendation of any particular intermediary or any security. Consult your own CPA or attorney before acting.