Key Takeaways
- The QI holds exchange proceeds, documents the exchange, and facilitates the replacement closing—the investor never touches the funds.
- QI due diligence: verify fidelity bond ($5M+), segregated accounts, financial stability, FEA membership, and no disqualified person relationships.
- LandAmerica's 2008 failure lost $440M in client exchange funds—QI selection is a fiduciary-level decision.
- Require segregated (not pooled) accounts with FDIC insurance and independent bank statements for verification.
The Qualified Intermediary (QI) is the essential third party who holds exchange proceeds between the relinquished and replacement property closings. The investor must never have actual or constructive receipt of exchange funds—this requirement makes QI selection one of the most consequential decisions in a 1031 exchange.
The Role of the Qualified Intermediary
The QI (also called an accommodator or facilitator) serves three critical functions. (1) Holds exchange proceeds: when the relinquished property closes, the sale proceeds are transferred directly to the QI—not to the investor. The QI holds these funds in escrow until the replacement property closes. (2) Documents the exchange: the QI prepares the Exchange Agreement (signed before the relinquished property closing), the Assignment and Notice documents (assigning the investor's position in the sale contract to the QI for exchange purposes), and the identification letter (documenting the investor's replacement property identifications within 45 days). (3) Facilitates the replacement closing: when the replacement property is ready to close, the QI releases the exchange funds to complete the purchase. The investor never touches the money—from the relinquished closing through the replacement closing, all funds flow through the QI.
QI Selection Criteria and Due Diligence
QI selection is critical because the QI holds the investor's exchange proceeds—often hundreds of thousands of dollars—for weeks or months. Due diligence includes: (1) Fidelity bond or errors & omissions insurance—the QI should carry at least $5M in coverage. (2) Segregated accounts—exchange funds should be held in a segregated, FDIC-insured account in the investor's name (or a segregated trust), not commingled with the QI's operating funds or other clients' funds. (3) Financial stability—verify the QI's financial condition. Several QI companies have failed, losing clients' exchange funds (most notably LandAmerica 1031 Exchange Services in 2008, which lost $440M in client funds). (4) Industry membership—membership in the Federation of Exchange Accommodators (FEA) indicates adherence to industry standards. (5) No disqualified person relationships—the QI cannot be someone who has acted as the investor's agent within the prior 2 years (attorney, accountant, real estate agent, or employee). QI fees typically range from $750-$1,500 per exchange.
Protecting Exchange Funds
The biggest risk in a 1031 exchange is loss of exchange funds due to QI insolvency, fraud, or commingling. Protection measures include: (1) Segregated accounts—require the QI to hold funds in a separate, interest-bearing account titled in the investor's name (or at minimum, a segregated trust account—never a pooled account). (2) Written security agreement—the exchange agreement should include provisions prohibiting the QI from using exchange funds for any purpose other than the exchange and requiring notification of any financial distress. (3) FDIC coverage verification—confirm that the bank holding the exchange funds provides FDIC insurance on the account (current limit: $250,000 per depositor, per institution). For exchanges exceeding $250,000, consider spreading funds across multiple FDIC-insured institutions. (4) Independent verification—request monthly account statements directly from the bank (not from the QI) to verify fund availability. The cost of these precautions is minimal; the cost of QI failure is total loss of exchange funds.
Key Takeaways
- ✓The QI holds exchange proceeds, documents the exchange, and facilitates the replacement closing—the investor never touches the funds.
- ✓QI due diligence: verify fidelity bond ($5M+), segregated accounts, financial stability, FEA membership, and no disqualified person relationships.
- ✓LandAmerica's 2008 failure lost $440M in client exchange funds—QI selection is a fiduciary-level decision.
- ✓Require segregated (not pooled) accounts with FDIC insurance and independent bank statements for verification.
Sources
Common Mistakes to Avoid
Selecting a QI solely based on lowest fees without verifying fund security protections
Consequence: If the QI goes bankrupt or embezzles funds, the investor loses the exchange proceeds with limited recourse—several high-profile QI failures have cost investors millions
Correction: Verify the QI's fidelity bond, E&O insurance, segregated account practices, and financial stability; the QI fee ($600-$1,200) is trivial compared to the funds at risk
Using the taxpayer's own attorney or CPA as the Qualified Intermediary
Consequence: A QI who has served as the taxpayer's agent within the prior 2 years is disqualified—the exchange will fail because the taxpayer is deemed to have constructive receipt of the funds
Correction: Use an independent, professional QI company with no prior agency relationship; the taxpayer's CPA and attorney can advise on the exchange but cannot serve as the QI
Test Your Knowledge
1.What is the role of a Qualified Intermediary (QI) in a 1031 exchange?
2.Which of the following disqualifies a person from serving as a Qualified Intermediary?
3.What protection should investors require from their QI regarding exchange funds?