Banking advisors and other professionals (attorneys, accountants, and the like) provide invaluable advice and outstanding service to their clients in the vast majority of cases.
But they must be wary when one of their clients comes to them asking about a Section 1031 exchange.
Banks often believe they are providing a service when they function as a “custodian of the funds” during a Section 1031 exchange, particularly banks where the exchange client has a preexisting relationship. Typically in these transactions the exchanger’s attorney handles the documentation. The problem is that most banks holding funds in an exchange are not actually or legally Qualified Intermediaries. Under Treasury Regulations, the taxpayer’s attorney, CPA or other existing advisors (for example, bank advisors) are disqualified parties and are expressly prohibited from serving in the capacity of Qualified Intermediary.
In actual practice, banks cannot disregard these specific requirements of Section 1031 if they wish to function as a Qualified Intermediary:
- The funds must be held in a qualified escrow account or in a qualified trust.
- The escrow holder or trustee cannot be a disqualified person.
- The taxpayer’s rights to receive, pledge, borrow, or otherwise obtain the benefits of the cash or cash equivalent held in the escrow account or by the trustee must be limited to circumstances specified in Treasury Regulation 1.1031(k)-1(g)(6).
- The qualified escrow agreement or trust agreement must incorporate the integrated terms of the exchange, including binding the non-exchanging parties, providing the necessary series of interdependent transfers, directing the flow of monies, identification and other Section 1031 requirements.
In practice, however, banks will often just set up a bank account and deposit the funds without meeting any of the above requirements. What’s the downside? The downside is the complete rejection of the exchange by the Internal Revenue Service, resulting in tax liability plus potential penalties and interest.
Iowa Equity Exchange. Why take a chance and use a disqualified party as your QI, exposing you to major problems down the road? At Iowa Equity Exchange, we provide true independent third-party qualified intermediary services. We do it day in and day out. We know our business and the laws that govern tax-deferred exchanges. Our fee is reasonable ($695) and our exchange accounts pay competitive market rates with no bank fees.
Click here for Kens article on the Anatomy of a 1031 Exchange.
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