I recently had the opportunity to spend some time with Julie Tumbaga, a Vice-President of OREXCO, which is a qualified 1031 exchange intermediary company. It was a great learning experience and I thought I’d share some Q&A with her to the readers of the blog. If you would like to reach Julie, she and her associates can be reached at (877) 591-1031 (toll-free from the neighbor islands) or 524-6737 on O’ahu.
Q: A 1031 exchange seems simple on the surface, but in learning more about them with you, I found that there was a lot more to them (and a lot more options for investors) than I had previously thought. In principle the idea is simple, but there are a lot of nuances to the process and legalities of a 1031 exchange. In your experience, what are several of the biggest areas of confusion for people considering or executing a 1031 exchange?
A: There are a number of things…
1. They have to reinvest both their basis and their gain, not the net proceeds. So, if they sell something for 500K, the replacement property needs to be equal to or greater than 500K for 100% deferral.
2. They need to be selling and purchasing like-kind property. Like-Kind is any combination of real property to include single family homes, condominiums, vacant land, commercial, industrial, golf courses and leasehold property with more that 30 years remaining on the lease. All properties need to be used for investment or for productive use in a business or trade.
Q: In continuing in the same general area of question, what is the single largest mistake you see people make (that could risk their tax-deferral) when doing a 1031 exchange?
A: A couple of things…..
1. They don’t identify property timely
2. They don’t use all of their money because they got a mortgage that is too high.
3. Don’t consult with their CPA or tax advisor.
Q: I know that depending on the type of exchange, the duties and responsibilities of a Qualified Intermediary (QI) can vary greatly but can you give us a description of some of the duties of a Qualified Intermediary (QI) in most tax-deferred 1031 exchanges?
A: Some of the duties include:
- Consult with your tax advisor to assure your transaction is properly structured to qualify for tax-deferred status;
- Prepare the legal documents necessary to facilitate your transaction, including: the exchange agreement, the assignment, the exchange contract addendum and the exchange account closing summary.
- Execute closing documents and where necessary, reviews and executes financing documents;
- Acts as the principal, by way of an assignment, in your purchase and sale transactions
- Holds your exchange proceeds so that you do not have actual or constructive receipt of the funds; and
- Coordinates with your real estate agent, tax advisor and/or attorney, escrow/closing officer and lender to ensure the smooth and accurate processing of your exchange transaction.
Q: One of the things I learned from you is that there are no established standards or guidelines for someone to call themself a QI. No national licensing, no experience or financial requirements and no genuine oversight. Since a QI is often handling significant amounts of money and/or titles to real estate, this is a serious risk to consumers and investors. What questions should someone considering a 1031 exchange ask of their Qualified Intermediary to be sure that their money and property are safe?
A: Some things to ask would be:
- What is the QIs financial strength? Obtain a copy of the QIs annual financial statement.
- Does the QI have a fidelity bond? If so, what is the amount?
- Does the QI have professional liability insurance? If so, what is the amount?
- Can the QI provide a written guarantee?
- Where is the QI holding the funds? In an investment account or bank account?
- Is an account summary available on demand?
- Is the QI subject to and compliant with Sarbanes-Oxley?
- Is the QI an independent organization/entity or is it affiliated with a larger corporate parent and/or sister company (ies) with substantial assets?
Q: In most real estate transactions, we already have buyers, sellers, buyer’s agent, seller’s agent and the escrow officer involved. When its a 1031 tax-deferred exchange, we also have the Qualified Intermediary company and its representatives involved to make sure that the IRS deadlines and requirements are met to ensure a legal exchange. What would your advice be to these other parties so that the transaction can move ahead quickly efficiently and legally?
A: Whenever there is an exchange, everyone needs to talk to each other. Agents, Lenders and Escrow….we all have our own specialties, however, when there is an exchange involved, some of the normal everyday practices don’t suit the exchange. So constant communication is vital so there are no surprises at the end.