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1031 Property Exchanges: Keeping it Simple
| | Wednesday, October 23, 2002 @ 05:00 AM EDT
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Contributed by: Larry Mayer
Larry Mayer Properties
Read more archived articles about Law and Legal Issues
In my last article, “…Don’t be Duped,” I promised to provide more insight into the 1031 exchange process. That article explained that there are many, many zealous companies out there that will gladly take your money and serve as your qualified intermediary. If you are a serious real estate investor, expecting to periodically trade property, you will undoubtedly be faced with the need to consider a 1031 exchange. The question: What to do about the QI?
If ever you became baffled by the massive legal and tax details described by typical 1031 qualified intermediary service companies, you’re not alone. I would expect that confusion is just what they’re counting on. The more confused you are, the more convinced you will be in using their “experts.” Heaven forbid the real secrets of 1031 exchanges should be divulged to the average real estate investor.
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If you were a fly on the wall, overlooking the desk of a typical QI service provider, conducting a “forward exchange” of property (where the exchangor sells one property before purchasing the next), you would likely be amazed at just how little activity is involved for the QI. With that knowledge, you would also likely be appalled at the price tag of that service.
A typical process for a QI for a forward exchange goes something like this:
1. The QI receives the signed exchange agreement and files it.
2. The QI receives the money from the sale of your relinquished property in his escrow account.
3. The QI receives your list of identified replacement properties (within 45 days) and files it.
4. The QI sends the escrowed money to the seller of the replacement property as you direct him.
5. You pay his fee. Typically, $2,000 to $20,000 depending on the property you exchanged.
Is it really that easy? Yes, it is. Despite the extensive library of 1031 materials that you can obtain from their websites and other sources, nearly all will emphatically state that they provide no legal or tax counsel. That advice must come from your own advisors. You must discuss with them such questions as “How much “boot” will result in my exchange? or “Is this property “like-kind? etc. When those questions are answered and you’re ready for the exchange, then the QI steps in. The QI serves as the middle-man, essentially holding paperwork and money during the exchange period - nothing more. Yet often an exchangor will pay much less to his attorney or accountant, in answering the tough questions, than he will pay to the QI. I know. I’ve been there.
I’ve served on both sides of the transaction. In my practice as an attorney, I’ve actually provided (non-client) QI services and have also represented clients in transactions in which they’ve used other independent QI’s. What is particularly frustrating, is seeing the QI services price tag fluctuate wildly, depending upon the value of the exchanged property. Why should that be, when the process and paperwork is virtually identical for a $100,000 property or a $10,000,000 property? I believe it is because many are willing to pay the inflated fee, believing perhaps that they are getting some better protection for their very valuable asset. It’s simply not true. The process is the same. Following the very simple 1031 procedures gives the exchangor the very same protection, regardless of the property’s value.
Some have wondered, “Is it the “qualified” status of the intermediary that justifies the fee?” No. “Qualified” simply means “not disqualified.” The simple truth is, even your close friend or next door neighbor would likely be qualified to serve as your intermediary. How much would he or she charge you for the same service?
True story: I had recently discussed the 1031 process with another attorney acquaintance. He informed me that although he didn’t understand the process very well, his father, who is a real estate investor, very recently looked into the process regarding one of his transactions. He carefully weighed the decision to pay several thousands in capital gains taxes, versus paying several thousands to a QI. I don’t know what the final decision was, but I was told by the attorney that his father was quite frustrated at the dilemna in which he found himself. He knew that QI service fees were not justified, but he felt he had no alternative. How I wish I could have told him that an alternative does actually exist!
If you’re serious about real estate investing, you need to think seriously about your options when it comes to 1031 exchanges. Please, once again, don’t be duped!
Note: Larry J. Mayer is the creator of The QI Guide. The QI Guide is software that can help you move property in the IRC 1031. If you plan on doing a 1031 exchange, this software is a must.
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