Key Takeaways
- Engage a QI before listing the relinquished property—the exchange agreement must precede closing.
- Begin replacement property search before Day 0 to reduce pressure during the 45-day identification window.
- The Three-Property Rule (up to 3 properties, any value) is the most commonly used identification method.
- The investor must never have constructive receipt of exchange proceeds—all funds flow through the QI.
Executing a 1031 exchange requires meticulous coordination between the seller, buyer, Qualified Intermediary, title company, lender, and real estate agents. A single misstep—touching the proceeds, missing a deadline, or improperly identifying replacements—can invalidate the exchange and trigger immediate tax liability. This lesson provides the step-by-step execution workflow.
Selecting and Engaging a Qualified Intermediary
The Qualified Intermediary (QI) is the linchpin of a 1031 exchange. The QI holds sale proceeds in escrow, prepares exchange documents, and ensures IRS compliance. Select a QI before listing the relinquished property—the exchange agreement must be in place before closing. Key selection criteria: experience (500+ completed exchanges), fidelity bond and errors and omissions insurance, segregated escrow accounts (never commingled), FDIC-insured depository, transparent fee structure ($750-$1,200 typical fee), and no related-party relationships with the investor. The QI cannot be someone who has served as the investor's attorney, accountant, broker, or agent within the preceding 2 years.
Replacement Property Identification Strategy
The 45-day identification period begins at the close of the relinquished property. To avoid the pressure of a tight deadline, begin identifying replacement candidates before the relinquished property closes. Develop a target list of 5-10 potential replacements and narrow to your final identifications during the 45-day window. The identification must be in writing, signed by the investor, and delivered to the QI. Under the Three-Property Rule, identify up to 3 properties of any value. Under the 200% Rule, identify any number of properties whose combined fair market value does not exceed 200% of the relinquished property's sale price. Under the 95% Rule, identify any number of properties if you close on at least 95% of their combined value. Most investors use the Three-Property Rule for simplicity and flexibility.
Coordinating the Replacement Property Closing
Once a replacement property is identified and under contract, coordinate closely with the QI, title company, and lender to ensure the exchange funds are properly routed. The QI sends the exchange proceeds directly to the title company at the replacement property closing—the investor never has constructive receipt of the funds. The replacement property must close by Day 180 (or the investor's tax return due date, including extensions, whichever is earlier). If the replacement property closing is delayed, request a closing extension from the seller and notify the QI immediately. If closing cannot occur by Day 180, the exchange fails and all deferred gains become taxable in the year of the relinquished property sale.
Key Takeaways
- ✓Engage a QI before listing the relinquished property—the exchange agreement must precede closing.
- ✓Begin replacement property search before Day 0 to reduce pressure during the 45-day identification window.
- ✓The Three-Property Rule (up to 3 properties, any value) is the most commonly used identification method.
- ✓The investor must never have constructive receipt of exchange proceeds—all funds flow through the QI.
Sources
Common Mistakes to Avoid
Using the same attorney or title company as the QI instead of an independent third party
Consequence: Related parties cannot serve as Qualified Intermediaries under IRS rules—using one disqualifies the entire exchange
Correction: Engage an independent, bonded QI with no prior relationship to the buyer, seller, or their agents within the past two years
Verbally identifying replacement properties instead of providing written identification
Consequence: Only written identification signed by the exchanger and delivered to the QI before the 45-day deadline is valid—verbal identification has no legal standing
Correction: Prepare written identification letters specifying each property by address and deliver them to the QI with confirmation of receipt well before Day 45
Test Your Knowledge
1.When must a Qualified Intermediary be engaged relative to the closing of the relinquished property?
2.What document formally identifies replacement properties in a 1031 exchange?
3.What role does the Qualified Intermediary serve in a 1031 exchange?