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Can A Simultaneous 1031 Exchange be Done Without the Use of a Qualified Intermediary?

Martin Edwards, JD, CES®
04/11/24
This article discusses the differences between simultaneous and delayed 1031 Exchanges, highlighting the complexities and risks associated with simultaneous exchanges when a Qualified Intermediary is not engaged. While it's possible to conduct a valid exchange without a Qualified Intermediary (QI), the article emphasizes the benefits of using a QI for both types of exchanges to ensure compliance with IRS requirements and provide added assurance through the safe harbor structure.
Using a QI for a Simultaneous 1031 Exchange

Simultaneous Exchange versus Delayed Exchange 

Most 1031 Exchange s take place on a delayed basis.  That is to say that the Exchanger sells his Relinquished Property to a buyer of choice and acquires Replacement Property from a seller of choice within 180 days thereafter, or by the due date for filing the tax return for the year of the sale, hence a delay in completed the exchange.  However, on occasion, there are just two or three parties who wish to directly exchange properties.  Because circumstances exist, they are able to exchange properties simultaneously, i.e. at the same exact time, rather than on a delayed basis.   

Facing the circumstances of a simultaneous exchange, including the absence of the requirement of holding funds until the close of a transaction to complete the exchange present in a delayed exchange, the parties sometimes consider entering into a 1031 Exchange transaction without involving a Qualified Intermediary. While this can be done, as the use of a  

Qualified Intermediary is not a precondition to a valid 1031 Exchange transaction, there are reasons why an Exchanger might want to use the same structure for a simultaneous 1031 Exchange that is customarily used for a delayed 1031 Exchange . 

A simultaneous exchange may seem as simple as two parties exchanging deeds to their properties of the same fair market value to complete a valid 1031 Exchange or one party paying in cash to equalize the values. However, there is more to it, much of which being proper processes and documentation are often overlooked. Should an audit occur, the documentation will be relied upon to determine if the 1031 Exchange stands up to IRS scrutiny.  

Criteria for a Valid 1031 Exchange 

As mentioned above, there are certain requirements that must be met for a valid 1031 Exchange in addition to merely exchanging properties via title transfer and possibly cash from one party to make up for a difference in fair market value.  

Intent to Exchange 

For a 1031 Exchange to be valid, there has to be an expressed intent to exchange requiring the purchase and sale of the properties to be reciprocal and mutually interdependent. The typical tax deferred exchange agreement contains language covering this requirement. Without more, a standard form Purchase and Sale Agreement would not contain necessary language to this effect. The presence of an “exchange cooperation clause” in a form contract would not suffice for this purpose. 

Exchange Requirement  

One of the primary drivers of the 1991 exchange regulations was to provide a way to maintain an “exchange event” between the parties while effectively taking the Exchanger’s buyer and seller out of the active participation in the Exchanger’s 1031 Exchange transaction. This was accomplished through the use of a new player, the “Qualified Intermediary” (QI). The idea was that the QI could substitute for the Exchange r’s buyer and seller as the party with whom the Exchange r was exchanging the properties, i.e. an intermediary in the middle of the transaction. The buyer and seller could be just that, they did not have to actively participate in the exchange. However, a simultaneous exchange without the use of a QI requires those other parties to be involved in the exchange and that is not always something they are willing to undertake. The buyer would have to agree to obtain the property from the Seller in lieu of paying the Exchange r and to transfer that property to the Exchange r. Likewise, the Seller would have to agree to sell the property to the buyer in lieu of the Exchange r. Contracts between the parties would have to be consistent with this. Proper conveyances would need to be made, reps and warranties might have to run to parties other than the person to whom the property was being transferred to or from, etc. Certain jurisdictions may seek to impose transfer taxes on some of the conveyances. 

Actual or Constructive Receipt of Funds 

Further, an Exchange r cannot be in actual or constructive receipt of any sale proceeds during the pendency of a 1031 Exchange . When using a QI, including its secondary role of holding the exchange proceeds, even for a transitory moment, the regulations provide that with proper language in the exchange agreement and/or an accompanying “qualified escrow” agreement, the Exchange r will not be deemed to be in actual or constructive receipt. Conversely, with a simultaneous exchange using a routine closing escrow, that document may not have the type of language which insures against actual or constructive receipt. 

Inexpensive Insurance 

It is often said that a person’s purchase of their home might be the most significant purchase they make during their lifetime. Purchasing an investment or business use property is also a very significant event and so is the certainty of receiving tax deferral via a successful 1031 Exchange .  

A buyer of a new home would not consider buying such an important property without the protection of title insurance. The 1031 Exchange regulations provide a “safe harbor” structure for the exchange of properties. The use of a Qualified Intermediary, such as Accruit, assures for a 1031 Exchange within the safe harbor to be preapproved by the IRS, which is equivalent to receiving title insurance. Think of it as Exchange Insurance. The cost of a 1031 Exchange is generally a minor amount, especially when considering the tax deferral at stake, so it is often considered a worthwhile expense to assure the transaction meets with the IRS requirements. 

The drafters of the regulations understood while it is possible to do an exchange without using a Qualified Intermediary, Exchange rs might like to take advantage of the safe harbor and the assurance it provides. So, they addressed this issue in the Preamble to the 1991 Regulations: 

Extension of safe harbor rules to simultaneous exchanges  

The rules in the proposed regulations, including the safe harbors, apply only to deferred exchanges. Commentators noted that the concerns relating to actual or constructive receipt and agency also exist in the case of simultaneous exchanges. They requested that the safe harbors be made available for simultaneous exchanges. Upon review, the Service has determined it necessary to make only the qualified intermediary safe harbor available for simultaneous exchanges. The final regulations provide, therefore, that in the case of simultaneous transfers of like-kind properties involving a qualified intermediary, the qualified intermediary will not be considered the agent of the taxpayer for purposes of section 1031 (a). Thus, in such a case the transfer and receipt of property by the taxpayer will be treated as an exchange. This provision is set forth in new §1.1031 (b)-2 of the final regulations and is effective for transfers of property made by taxpayers on or effective for transfers of property made by taxpayers on or after June 10, 1991. 

In sum, while it is possible to structure a valid 1031 Exchange without engaging the services of a Qualified Intermediary, but there are some risks that certain required elements might inadvertently be missed invalidating the 1031 Exchange . Tax deferral is a gift, but to receive it, technical adherence is a necessity.  The drafters of the regulations understood this and chose to make the rules applicable to simultaneous 1031 Exchange s. The safe harbor structure set forth in the applicable regulations provide “exchange insurance” and the cost is minimal compared to the benefit of knowing the structure is preapproved.  

 

 

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified  Intermediary , and as such does not offer or sell investments or provide investment, legal, or tax advice.