Who Handles a 1031 Exchange? – Don’t Make This Mistake + FAQs

The Qualified Intermediary (QI) is the central figure who handles a 1031 exchange. Under federal law (Internal Revenue Code §1031 and Treasury Regulations), any taxpayer doing a 1031 exchange must use an independent third-party intermediary to facilitate the transaction.

This impartial third party is often called a Qualified Intermediary, sometimes known as an exchange accommodator or exchange facilitator. The QI’s role is to step in and handle the exchange process so that you, the seller, do not directly receive the sale proceeds – a critical requirement to qualify for tax deferral.

Federal Requirements: Why a Qualified Intermediary Is Mandatory

The IRS mandates the use of a Qualified Intermediary to prevent “constructive receipt” of funds by the seller. In simple terms, if you touch the money from the sale of your property, even for a moment, the IRS will consider it a taxable sale rather than part of an exchange. To avoid this, the QI holds the sale proceeds in trust between the sale of your old (relinquished) property and the purchase of your new (replacement) property. The QI essentially handles all the funds and paperwork during the exchange period.

Key duties of a Qualified Intermediary include:

• Preparing Exchange Documents: The QI drafts the necessary exchange agreement, assigning rights in the sale and purchase contracts to itself. This makes the QI the substitute seller of your old property and buyer of your new property (on paper) to qualify as a swap.
• Holding Funds in Escrow: When you sell the relinquished property, the QI receives the proceeds directly. The funds are kept in a segregated account (often an escrow or trust account) under the QI’s control. You won’t have access to this money during the exchange.
• Facilitating Identification of Replacement Property: The QI provides forms or an online portal for you to identify potential replacement properties within 45 days of selling your old property. They receive your identification letter and keep it on record as required by the IRS.
• Coordinating Closings: The QI works closely with your escrow or title company and real estate agents during both the sale and purchase closings. They ensure the exchange language is in all documents and that sale proceeds flow directly from the QI to purchase the new property when you close on the replacement. At no point do you receive the money directly.
• Ensuring Compliance: A good QI continuously guides and monitors the exchange timeline, making sure you meet the IRS deadlines (45-day identification and 180-day completion rules) and follow all rules. They will also provide you with a final accounting and the necessary information to file with your tax return (IRS Form 8824).

In short, the Qualified Intermediary handles the 1031 exchange from start to finish, acting as the keystone that makes a like-kind exchange possible under federal law. Without a QI, a standard delayed 1031 exchange simply cannot be completed successfully, as you would violate IRS rules by receiving funds or property directly.

State Nuances: How Local Laws Affect 1031 Exchange Handling

Section 1031 is a federal tax law, so its core rules apply in all states. However, states can have their own nuances in how exchanges are handled or taxed:

• State Regulation of QIs: While there is no federal licensing for Qualified Intermediaries, some states regulate exchange facilitators for consumer protection. As of now, eight states have specific laws governing who can handle a 1031 exchange and how they must safeguard clients’ funds. These states include examples like California, Colorado, Idaho, Maine, Nevada, New Hampshire, Virginia, and Washington. Such regulations often require QIs to have fidelity bonds, insurance, separate client trust accounts, and sometimes state registration or licensing (Nevada, for instance, mandates a state license for QIs). This means if your exchange is handled in one of these states, the QI must meet additional standards – a good thing for investors, as it adds layers of protection against fraud or loss.

• State Tax Treatment Variations: On the tax side, most states conform to federal 1031 rules, meaning they also allow you to defer state capital gains tax as long as you complete a valid exchange. However, a few states have quirks. Pennsylvania, for example, does not recognize 1031 exchanges for state tax purposes – if you sell Pennsylvania real estate and do a 1031 exchange, you might still owe Pennsylvania state tax on the sale (even though federal tax is deferred). Other states might require special forms or withholding during the exchange. Always check your state’s stance: in most cases, state capital gains tax is deferred alongside federal, but exceptions exist.

• Local QI Presence: Some investors wonder if they need a local Qualified Intermediary. Because 1031 exchanges are federal, you can use a QI located anywhere in the U.S. (and many operate nationally). However, if your state has QI regulations, ensure the QI you choose complies with those rules. Many major QIs are well-versed in handling exchanges across all states, adjusting for any state-specific requirements.

Bottom line: At the federal level, a Qualified Intermediary is the required handler of any standard 1031 exchange. State laws may add additional consumer protections or tax nuances, but they do not remove the necessity of a QI. Always use a reputable QI who adheres to both federal rules and any relevant state regulations. It’s the surest way to keep your exchange on track and fully tax-deferred.

Avoid These 1031 Exchange Pitfalls and Traps

A 1031 exchange can save you a tremendous amount in taxes, but the process must be executed carefully. Even with a Qualified Intermediary handling the exchange, there are common pitfalls and mistakes that can derail your tax deferral. Here are critical things to avoid:

• Taking Possession of Funds: Never directly receive the sale proceeds from your relinquished property. If the money even briefly hits your bank account or you have constructive receipt of it, the IRS will disqualify the exchange. Make sure all proceeds go straight to the QI’s escrow account at closing. Avoid any arrangement where you “hold” the funds, even as a short-term loan – it’s not allowed.

• Missing the Deadlines: The 1031 exchange timeline is unforgiving. You have 45 days from the sale to identify potential replacement properties, and 180 days from the sale to close on the replacement (the clock starts the day after you sell the first property). These are calendar days and include weekends/holidays. There are virtually no extensions (except rare federally declared disaster relief). Missing day 45 or day 180 means your exchange fails. Plan early and work closely with your QI to ensure you meet these dates. Avoid waiting until the last minute to identify or close; unexpected delays can happen.

• Identifying Improper Properties: During the identification period, you must identify like-kind replacement properties in a formal way (usually a letter to your QI). Avoid naming properties that you aren’t actually serious about or that don’t qualify. The IRS has rules on how many properties you can identify (typically up to three properties of any value, or more under strict value conditions). If you identify the wrong type of asset (for instance, personal property which no longer qualifies, or a property outside the U.S. when your relinquished was U.S. real estate), or if you fail to correctly document the identification, your exchange could be at risk. Stick to qualifying like-kind real estate and follow your QI’s guidelines for identification.

• Using a Disqualified Intermediary: Not just anyone can serve as your intermediary. Avoid using a person or entity that is “disqualified” under IRS rules. Disqualified persons include yourself, obviously, and close family members. It also includes any agent or fiduciary who has worked for you in the past two years – for example, your real estate attorney, accountant, financial advisor, or real estate broker cannot act as your QI if they provided services to you recently. Using a disqualified party as an intermediary will invalidate the exchange. Stick to a neutral, professional QI with no prior relationship to you (aside from handling past exchanges, which is allowed). Reputable QI companies know these rules; be wary of any individual offering to hold your funds if they don’t meet the independence criteria.

• Improper Vesting or Title Issues: The taxpayer who sells must be the one who buys. Avoid changing who holds title between the sale and purchase. For example, if John Smith sells the old property, John Smith (or an entity he wholly owns, if set up that way consistently) must buy the new property. You generally cannot sell in your name and have your LLC buy, or vice versa, without jeopardizing the exchange (unless done under proper structuring advice). Similarly, don’t plan to add partners or change the ownership form during the exchange without consulting an expert – it could be considered cashing out someone’s share (taxable “boot”).

• Failing to Reinvest Fully (Boot Pitfalls): If you don’t purchase property of equal or greater value and reinvest all the cash proceeds, the leftover cash or debt reduction is called boot, which is taxable. It’s fine to have boot if you’re okay paying some tax, but avoid accidental boot. For instance, if you sell for $500,000 and only buy a $400,000 property, the $100,000 difference (minus exchange expenses) is taxable. Also, if your replacement property has a smaller mortgage than the relinquished property, that debt reduction counts as boot unless offset by adding cash. Work with your QI and advisors to plan your replacement purchase so that you use up all the exchange funds and maintain or increase your debt level (if any) to fully defer tax. Don’t mistakenly assume any new purchase works—value and equity matter.

• Choosing a Questionable QI: Most QIs are legitimate businesses, but as with any financial service, there have been rare cases of bad actors. Avoid entrusting your exchange to a facilitator who does not provide answers about how your funds will be held, or who lacks insurance/bonding. Do your due diligence: check if the QI is a member of the Federation of Exchange Accommodators (FEA) or if they employ Certified Exchange Specialists. Ask if your funds will be in a separate qualified escrow account with your name (many QIs do this for safety). Avoid any intermediary who commingles funds or promises oddly high interest rates (it could indicate risky investments with your money). A 1031 exchange may involve large sums, so it’s worth using a trusted, well-established QI.

By steering clear of these pitfalls and working closely with qualified professionals, you greatly increase the chance your 1031 exchange will go smoothly. Remember that one mistake can void the entire tax deferral, so attention to detail is key. When in doubt, consult experienced 1031 advisors (tax attorneys or CPAs) before you make a move that could jeopardize your exchange.

Decoding Key 1031 Exchange Terms (Glossary)

Navigating a 1031 exchange means encountering some technical jargon. Understanding these key terms will help you communicate effectively with intermediaries and advisors, and grasp who does what in the exchange process. Here’s a quick glossary of important 1031 exchange terms:

Knowing these terms will make it much easier to follow the mechanics of a 1031 exchange and communicate with the professionals helping you. Essentially, the Qualified Intermediary (QI) is the term for who handles the exchange, the Exchanger is you, and all the other terms describe what’s being exchanged and the rules around it. Keep this glossary handy as you plan your exchange, so you can quickly decode any 1031 lingo you encounter.

Real-Life 1031 Exchange Examples: From Sale to Purchase

To truly understand how a 1031 exchange is handled, let’s walk through a couple of detailed examples. These scenarios illustrate the role of the Qualified Intermediary and the sequence of events in different exchange situations.

Example 1: Standard Delayed Exchange of Investment Properties

Scenario: Jane owns a small rental duplex that she bought years ago for $200,000. It’s now worth $500,000. She wants to sell it and use the proceeds to buy a larger apartment building for $600,000. A 1031 exchange will allow her to defer taxes on her ~$300,000 gain from the duplex sale.

Step 1 – Engaging a QI: Before Jane closes the sale of her duplex, she contacts a reputable Qualified Intermediary company and sets up an exchange account. She signs an exchange agreement with the QI prior to closing the sale. The QI provides instructions that at closing, the sale contract will be assigned to the QI.

Step 2 – Selling the Relinquished Property: Jane sells the duplex for $500,000 on June 1. At the closing, the title company has Jane sign documents assigning her interest to the QI for exchange purposes. The buyer pays $500,000 (less any closing costs) and the funds go directly to the QI’s escrow account. Jane does not receive any of the money. The QI now holds, say, $480,000 (after closing fees) on Jane’s behalf.

Step 3 – 45-Day Identification: Starting June 2, the clock is ticking. Jane has until July 16 (45 days) to identify replacement property. With the help of her real estate agent, she finds a promising 10-unit apartment building and an alternative option of a 4-plex in case the first deal falls through. She submits a written identification letter to her QI listing these two properties (both are like-kind real estate). She does this on Day 30, well before the deadline, to be safe.

Step 4 – 180-Day Purchase: Jane enters a purchase contract for the 10-unit building at $600,000 and proceeds to closing. The QI formally assigns the purchase contract to itself (for Jane’s benefit) just as it did with the sale. On September 15 (within 106 days from her sale, so within the 180-day limit), Jane closes on the new property. At closing, the QI wires $480,000 (all the money it held from the sale) to the title company. Jane uses a new loan for the remaining $120,000 and a bit of extra cash for closing costs to make up the $600,000 price. The title transfers directly from the seller of the new property to Jane (the QI doesn’t keep it; it’s a pass-through). The QI’s role is complete after the closing, and they provide Jane with final documentation of the exchange.

Result: Jane successfully purchased a more expensive property and reinvested all the proceeds, so no capital gains tax is due on the sale of her duplex. She will report the exchange on Form 8824, but thanks to the QI’s proper handling, the IRS will see she followed all rules. Jane has effectively traded up her investment without losing a chunk of her equity to taxes, leveraging the full $480,000 (plus new financing) to grow her portfolio.

Key Takeaway: In this standard delayed exchange, the Qualified Intermediary handled the funds and paperwork at each step. Jane never touched the money, and she followed the identification and purchase timeline. The QI coordinated with the closing agents and kept the process on track. This is a textbook example of how a QI handles a 1031 exchange to achieve a seamless tax-deferred swap.

Example 2: Reverse Exchange – Buying First, Selling Later

Scenario: Robert finds an ideal commercial property for $1 million that he wants to buy, but his current property (a warehouse) hasn’t sold yet. The seller of the new property won’t wait, so Robert decides to do a reverse 1031 exchange – buying the replacement first and selling his old warehouse afterward. This is trickier because Robert cannot own both properties at the same time during the exchange; otherwise, it wouldn’t be an exchange. He needs a creative solution through his intermediary.

Step 1 – Setting Up an EAT: Robert works with a Qualified Intermediary that offers reverse exchange services. The QI sets up a limited liability company as an Exchange Accommodation Titleholder (EAT). This EAT will temporarily take title to one of the properties to park it until the exchange is complete. Robert and the QI decide the EAT will hold title to the new property when purchased, because Robert still needs to arrange the sale of his old warehouse.

Step 2 – Buying the Replacement Property First: On March 1, the EAT (on behalf of the QI) purchases the new commercial property for $1,000,000. Robert arranges financing and puts down money, but the title is taken in the name of the EAT (such as “123 Exchange LLC, as titleholder for Robert’s exchange”). The EAT is effectively holding the property for Robert. The clock starts ticking on the 180 days; by August 28, Robert must have sold his old property and transferred the new one to himself to complete the exchange.

Step 3 – Selling the Relinquished Property: Robert now focuses on selling his warehouse. He secures a buyer and closes the sale on June 15 for $800,000. At this closing, as usual, the QI steps in: the sale proceeds of $800,000 go to the QI’s account, not to Robert. Robert has now “relinquished” his old property, albeit after acquiring the new one.

Step 4 – Completing the Exchange Transfer: With the old property sold, the QI can now transfer the new property from the EAT to Robert to complete the exchange. The QI uses the $800,000 of sale proceeds it’s holding to essentially “buy” the new property from the EAT and give it to Robert. In practice, the EAT transfers the deed to Robert. Robert had initially put some of his own money to help buy the new property (because it cost more than $800k), and that counts as additional equity in the exchange. The transfer to Robert is completed by early July.

Result: Robert now owns the new commercial property outright, and his old warehouse is sold. The QI, through the EAT, allowed him to acquire first and sell later. For tax purposes, it’s as if the QI/EAT bought the new property and held it until Robert’s sale happened, then the exchange was made. The $800,000 from the sale was fully used toward the new purchase price (and Robert added extra cash to reach $1M). Therefore, Robert has successfully deferred the capital gains tax on his warehouse sale via this reverse exchange. It was more complex (and incurred higher QI fees for the EAT structure), but it enabled him to secure the replacement property he wanted without missing out.

Key Takeaway: In a reverse exchange, the handling involves an extra layer – the EAT – and careful coordination by the Qualified Intermediary. The QI literally takes title to property through an EAT entity to avoid Robert holding both properties simultaneously. This example shows that different exchange formats still rely on intermediaries to navigate IRS rules. Whether selling first or buying first, a knowledgeable QI is integral to managing the process.

These examples demonstrate how an exchange is handled in practice by a QI and related parties. In each case, the exchanger could not have achieved the tax deferral without the intermediary stepping in to properly structure the deal. Whether it’s the straightforward delayed exchange (Example 1) or a complex reverse exchange (Example 2), the common theme is clear: a 1031 exchange is handled by professionals who ensure all rules are met, allowing the investor to reap the benefits.

Expert Insights and Evidence: Why Proper Handling Is Essential

The 1031 exchange process might seem cumbersome with all its rules and the need for a Qualified Intermediary, but these requirements exist for a reason. Experts universally stress that proper handling is essential – not just to satisfy legal technicalities, but to protect your financial interests. Here we share some expert insights and evidence underlining why you should entrust your exchange to experienced professionals and follow best practices.

• IRS Scrutiny and Strict Compliance: Tax experts point out that Section 1031 is one of the more closely scrutinized areas by the IRS because it grants a significant tax benefit. There is clear evidence in IRS regulations and court cases that if you stray from the rules, you lose the benefit. For example, many tax advisors recall instances where exchangers identified properties a day late or completed purchase on day 181 – and the IRS disallowed the deferral, resulting in full taxes owed. The rules leave no wiggle room. As evidence of how strictly the IRS views this: there is no hardship provision or appeal if you miss a deadline. Proper handling by a diligent QI can save you from such an expensive oversight. A seasoned intermediary will send reminders and double-check your identification notice, ensuring you don’t slip up on timing.

• Case of QI Fraud – Lessons Learned: In the mid-2000s, a few high-profile cases of fraud by unscrupulous intermediaries shook the industry. The most notorious example was a company whose owner misused clients’ 1031 funds for personal investments, leaving exchangers empty-handed and taxable. After this incident, industry groups and states pushed for more safeguards. The evidence of those mishaps is seen in the new state laws (like bonding requirements) we discussed earlier. Experts who lived through that era advise clients today to always use bonded, insured QIs, and even consider using QIs that keep funds in separate escrow accounts or qualified trust accounts for each exchange. While such fraud is extremely rare, it highlighted an important insight: you are handing over possibly hundreds of thousands or millions of dollars to the QI during the exchange period, so make sure that intermediary is above reproach. Reputable QIs welcome these questions and provide transparency about how your money is protected.

• Economic Impact and Policy Insights: Real estate economists and professionals often highlight how 1031 exchanges grease the wheels of the property market. By deferring taxes, investors are more willing to sell and reinvest, which increases transactions and economic activity. Some industry studies have shown that eliminating 1031 exchanges (a proposal that has surfaced in Congress from time to time) could lead to fewer real estate deals and lower property values in some sectors. This is evidence of the positive effect exchanges have. Experts use these insights to encourage investors: if the rules are followed, a 1031 exchange can be a powerful tool to leverage pre-tax dollars into new investments, amplifying portfolio growth. But the flip side is emphasized too: if you make a mistake and your exchange fails, you might be left not only with a tax bill but possibly unable to afford the new purchase after taxes. Proper handling avoids that scenario, letting you fully harness the exchange’s benefits.

• Professional Credentials Matter: Many Qualified Intermediaries today employ staff who have earned the designation Certified Exchange Specialist (CES), which is a credential awarded by the Federation of Exchange Accommodators (FEA) to individuals who pass a rigorous exam on 1031 rules and have significant experience. Experts often advise checking if your primary contact at a QI company is a CES or if the company is active in the FEA. While not legally required, these credentials and memberships are evidence of a commitment to expertise and ethical standards. Industry veterans note that exchange laws can evolve (for instance, the big change in 2018 when personal property was excluded), and having an intermediary who stays current on tax law changes ensures your exchange won’t run afoul of any new rules. The insight here: choose experts who demonstrate up-to-date knowledge – your tax deferral depends on it.

• The Network of Advisors: A successful 1031 exchange often involves a small network of professionals beyond just the QI. Savvy investors involve a tax advisor or CPA early to calculate how much they need to reinvest and to plan for any partial tax if necessary. They might involve a real estate attorney to review contracts, especially for complex deals or reverse exchanges. According to expert insights, involving these professionals is evidence of a prudent approach. While the QI handles the mechanics, your CPA and attorney ensure the strategy makes sense and all legal documents align (for example, ensuring the purchase and sale contracts include exchange cooperation clauses and that title is held correctly). Coordination among your QI, CPA, attorney, and agents is the recipe for a smooth exchange. Each has a role, and neglecting any one piece can introduce risk.

In summary, the consensus of experts and the historical evidence from both IRS enforcement and past industry pitfalls all point to one conclusion: proper handling by qualified professionals is absolutely essential in a 1031 exchange. This isn’t a do-it-yourself area of tax law. By entrusting the process to an experienced Qualified Intermediary and heeding the advice of tax professionals, you significantly improve the odds of a successful exchange. The costs for these services are relatively small compared to the tax savings at stake. As the saying goes in the 1031 world: “You only get one chance to do it right.” With millions of tax dollars on the line across the country each year, it’s clear why experts emphasize getting the right people to handle your exchange.

Delayed vs. Reverse vs. Improvement Exchanges: Who Handles Each Type?

Not all 1031 exchanges are alike. While the delayed exchange (sell first, buy later) is by far the most common, investors sometimes use other formats like simultaneous exchanges, reverse exchanges, and improvement exchanges. Each type has unique handling requirements and may involve additional parties or structures. Let’s compare the different types of 1031 exchanges and see who handles what in each scenario:

As shown in the comparison above, the Qualified Intermediary is central to every type of exchange, but the complexity and additional structures (like the EAT in reverse or improvement exchanges) vary. In all cases, some form of neutral party facilitates the swap:

• For delayed exchanges, the QI alone suffices to hold funds between the two transactions.
• For simultaneous exchanges, a QI or other arrangement is still strongly recommended because any glitch could turn it into a failed delayed exchange. Many will still engage a QI just in case, even if expecting to close both deals on the same day.
• For reverse and improvement exchanges, you cannot do it without a QI and their ability to set up an EAT. These are advanced strategies requiring a specialized intermediary who offers these services. Not all QIs handle reverse exchanges, but many do (often larger firms or those with specific expertise).
• A build-to-suit exchange is essentially a variation of a reverse exchange where the QI/EAT holds the property while it’s being improved.
• In a partial exchange, even though you’ll pay tax on the non-reinvested portion (boot), you still need a QI to facilitate the portion that is being exchanged, or else you get taxed on everything. So the handling is the same as a full exchange from the QI’s perspective.

Choosing the right intermediary is particularly important for non-standard exchanges. If you plan a reverse or improvement exchange, ensure the QI has a track record with those types and can navigate the logistics of holding property in an EAT, dealing with financing (e.g., some lenders are familiar with lending to an EAT structure), and managing the timeline.

By understanding these types, you can pick the exchange strategy that fits your situation and know what kind of handling it will entail. Regardless of type, remember: the exchange must be set up before you complete the transactions. For instance, you can’t decide after selling that you’ll do a reverse exchange – it must be arranged when you buy first. Early planning with your QI and advisors is crucial to match the right exchange structure to your needs.

The 1031 Exchange Ecosystem: Key Players and Their Roles

A successful 1031 exchange is a team effort. While the Qualified Intermediary is the central handler, several other key players work in concert to execute the exchange. Understanding who these players are and what roles they play will help you navigate the process more smoothly and communicate effectively. Here’s a look at the 1031 exchange ecosystem and how these parties relate to each other:

This network of players works together to make a 1031 exchange happen smoothly:

• Coordination and Communication: Typically, you (the Exchanger) will be in regular communication with your QI, your real estate agent, and possibly your CPA or attorney throughout the process. The QI communicates with the escrow officers for closings. All documents are shared appropriately. For example, the escrow agent gets a copy of the exchange agreement or instructions from the QI, and your CPA gets the final exchange statement for tax reporting.
• Checks and Balances: Each player provides a check or balance that helps ensure success. The QI focuses on rules and funds, the CPA double-checks financials and tax aspects, the attorney double-checks legal aspects, etc. If one spots an issue (say, the CPA notices you might inadvertently have boot), they can alert the team to adjust the plan.
• Your Responsibilities: As the exchanger, your main duties are choosing good professionals, being decisive in identifying and purchasing new property, and following the guidance given (like not touching the money, sticking to timelines). You should also inform all parties early that it’s a 1031 exchange so everyone can do their part correctly. Fortunately, a lot of the heavy lifting is on the professionals once you’ve engaged them, but staying informed (for instance, reading the documents the QI sends you and asking questions if anything is unclear) is wise.

In essence, who handles a 1031 exchange is not just one person – it’s a team. The Qualified Intermediary is the key handler, but they operate within this broader ecosystem of real estate and tax professionals. By knowing each player’s role, you can better manage the process, ensure everyone is on the same page, and catch any potential issues before they become problems. When all these players collaborate effectively, the 1031 exchange process can be almost routine, despite its complexity behind the scenes.

Case Studies: 1031 Exchange Successes and Failures

Nothing drives home the importance of proper handling in a 1031 exchange like real-world stories. In this section, we present two brief case studies: one illustrating a smooth, successful exchange handled by professionals, and another showing how an exchange can fail due to mistakes. These comparisons will highlight the dos and don’ts and the consequences of each scenario.

Case Study 1: Smooth Sailing with a Professional QI

Background: Maria is an investor who owns a small retail building. She has a savvy plan: sell the building and use a 1031 exchange to buy two rental properties in another state where she sees growth potential. Her gain on the sale is significant, so she knows a failed exchange would mean a huge tax bill.

Execution: Maria hires an experienced Qualified Intermediary recommended by her real estate attorney. The QI is bonded, has a long track record, and even assigns Maria a dedicated exchange officer who is a Certified Exchange Specialist. Maria involves her CPA from the start as well, to run projections and ensure she budgets correctly for buying two properties.

When Maria lists her retail building, her agent includes wording in the listing and contract about the seller’s intent to perform a 1031 exchange. A buyer is found and the sale closes with the QI in place. The QI seamlessly receives the $1.2 million in proceeds. Maria identifies three possible rentals to buy (with a combined value slightly above $1.2M to use all funds) by Day 30.

Her QI keeps in touch, and when Maria goes under contract on two of the identified properties, the QI coordinates with both escrows. By Day 120, Maria closes on both new rentals using all the exchange funds split between the two deals. The QI’s precise paperwork assigns each purchase to the QI for her benefit, and the deeds transfer to Maria upon closing. Both transactions are completed well before the 180-day limit.

Outcome: Maria’s exchange is 100% successful. She defers the capital gains tax on her sale, effectively rolling all her proceeds into the new investments untaxed. Her CPA files her tax return noting the exchange, and everything checks out.

Why It Succeeded: Maria’s success is due to careful planning and letting the professionals handle their parts:

• She engaged a top-notch QI before doing anything else.
• She communicated her plans to all parties (agent, buyers, sellers, CPA) so everyone cooperated.
• The QI expertly managed the funds and deadlines; there were no last-minute scrambles.
• Maria stuck to the timeline, identified appropriate properties, and closed on them promptly.

This case underscores that with the right support, a 1031 exchange can be a smooth process where the biggest “surprise” is just how straightforward it feels.

Case Study 2: A Cautionary Tale of a Failed Exchange

Background: Kevin sells a piece of land that he held for investment, expecting to do a 1031 exchange into a rental property. He’s a bit of a do-it-yourself type and thinks the exchange process sounds simple enough.

What Went Wrong: Kevin doesn’t research Qualified Intermediaries thoroughly. A friend of a friend says they can handle the exchange for a cheap fee, so Kevin informally entrusts them to be the intermediary. Unfortunately, this individual is not a legitimate QI – they’re a local real estate consultant with no bonded escrow account. When Kevin’s land sale closes, the title company, unsure about the exchange procedure, accidentally wires the proceeds directly to Kevin’s personal bank account (since Kevin did not have a formal QI agreement instructing them otherwise).

The moment those funds hit Kevin’s account, the IRS rules consider him to have received cash – the exchange is effectively disqualified. Kevin, realizing the mistake, quickly tries to fix it by moving the money to an escrow account and proceeding to buy a rental property within a month. He even finds a property and closes on it, thinking maybe he salvaged the situation because he bought a new property quickly.

Outcome: When Kevin’s CPA hears what happened, he has the unhappy task of informing Kevin that the exchange failed on Day 1 when he received the money. On Kevin’s tax return, the sale cannot be reported as a like-kind exchange. Instead, Kevin has to recognize the full capital gain from the land sale. The IRS does not care that he bought a new property afterwards – the fact that he had control of the funds broke the exchange. Kevin ends up owing a large sum in taxes that year, which he hadn’t fully planned for (he assumed the exchange would wipe it out). Additionally, that “friend” who was supposed to help had no insurance, and while they feel bad, there’s nothing they can do to reverse what happened.

To make matters worse, Kevin learned that if he had done it correctly, he could have deferred not only federal capital gains tax but also state tax. Because it failed, he owes both. And the new property he bought will at least give him depreciation and future appreciation, but he missed the big immediate benefit of deferral.

Lessons Learned:

• Kevin’s story highlights what not to do. He attempted to save a little on fees and handle things casually, but it cost him dearly in taxes.
• Always have a formal Qualified Intermediary agreement in place before closing a sale. If Kevin had hired a reputable QI, the title company would have sent the funds to the QI’s escrow, and the outcome would have been different.
• A proper QI would also have guided Kevin on the identification rules and documentation. Even though he bought a property quickly, other aspects could have tripped him up (for example, what if the property he bought wasn’t like-kind or he didn’t reinvest all the proceeds?).
• Don’t assume you can “repair” an exchange after a mistake. The IRS safe harbor rules must be followed from the start. Once broken, an exchange cannot be retroactively fixed.

This cautionary case study demonstrates that a seemingly small error – the funds going to the wrong place – can collapse a 1031 exchange. It reinforces the earlier advice: do not try to wing it. The cost of doing it wrong is far greater than the cost of doing it right with professional help.

These two contrasting stories emphasize why the question of “who handles a 1031 exchange” is so important. In Maria’s case, having the right handler (QI and team) led to a great outcome. In Kevin’s case, mishandling by an unqualified person led to failure. As an investor, you want your story to mirror Maria’s success: plan ahead, use the proper intermediary, and follow the rules diligently. With that formula, you can confidently reap the rewards of a 1031 exchange.

FAQ: Common Questions About 1031 Exchange Handling

Q: Do I need a qualified intermediary for a 1031 exchange?
Yes, a qualified intermediary is required by IRS rules to properly handle the funds and paperwork in a 1031 exchange. Without one, your exchange will fail and become a taxable sale.

Q: Can I handle a 1031 exchange myself without an intermediary?
No, you cannot directly handle the exchange yourself. The IRS prohibits you from receiving the sale proceeds. You must use an independent intermediary to hold the funds and facilitate the swap.

Q: Is a 1031 exchange only for real estate now?
Yes, as of recent tax law changes (2018), only real property qualifies for 1031 exchanges. You can exchange investment or business real estate for other real estate. Personal property is no longer eligible.

Q: Does a 1031 exchange require hiring an attorney or CPA?
No, a lawyer or CPA isn’t legally required to complete a 1031 exchange. However, it’s wise to consult them. They provide valuable advice and help with compliance, even though a qualified intermediary handles the exchange mechanics.

Q: Can I do a 1031 exchange across different states?
Yes, 1031 exchanges are federal and can be done between properties in different states. Just be mindful of each state’s tax rules—most follow federal law, but a few impose state taxes or have special requirements.

Q: Are qualified intermediaries regulated or licensed?
Yes, in some states intermediaries are regulated and may need to be licensed or bonded. There is no national license, but reputable QIs follow industry standards, carry insurance, and comply with any state laws to protect your funds.

Q: Can my real estate agent or broker hold the 1031 exchange funds?
No, your agent cannot hold the funds. Real estate brokers (as well as your attorney or CPA) are considered disqualified persons if they’ve worked for you recently. Only a true independent QI should hold the sale proceeds to maintain a valid exchange.

Q: Is a 1031 exchange worth it for smaller properties?
Yes, even for smaller investment properties, a 1031 exchange can be worth it if the tax savings outweigh the costs. By deferring taxes, you keep more equity to reinvest. Just ensure the anticipated capital gains tax is significant enough that deferral makes financial sense after QI fees and closing costs.