Can a Title Company Be a Qualified Intermediary?

Many real estate investors assume a title company can serve as their qualified intermediary (QI) in a 1031 exchange. But according to Internal Revenue Service (IRS) rules, this isn’t always true. First, the 1031 exchange process is an amazing provision in the Internal Revenue Code (IRC) that allows you to defer capital gains taxes when you sell a property.

However, to do this successfully, you must not touch the funds after the sale. Rather, it must be held in trust by a qualified intermediary, a third party that ensures you abide by all the stipulated IRC guidelines for the process.

While anyone with the right qualifications can apply to be a QI, the IRS has stringent rules to prevent property owners from cheating the system. Although the major option people opt for to avoid breaking these rules is to employ the services of a specialized qualified intermediary, title companies can be an alternative if they satisfy the right conditions.

Universal Pacific 1031 Exchange is California-based qualified intermediary firm, offering the professional 1031 exchange services. We take pride in giving our clients seamless and stress-free experiences, at the best QI fee rates possible. Although we’re domiciled in Los Angeles, we have nationwide coverage, with a resolve to help you enjoy tax benefits when you sell your properties. Book a free consultation with us now to get started.

In this article, we’ll explain how to use a title company to facilitate 1031 exchange transactions, the risks involved, and what to consider when choosing the right one.

Who Is a Qualified Intermediary (QI)?

A qualified intermediary is an unbiased third party who helps a taxpayer sell an asset and buy a replacement property within the IRC Section 1031 exchange guidelines. As far as this process is concerned, one of the major responsibilities of a QI is to ensure the taxpayer does not touch the proceeds from selling the relinquished property.

Instead, the QI will hold the exchange funds in trust and use it to buy a replacement property. Given that none of the rules are broken, the IRS would consider this a swap deal, thereby making it possible for the taxpayer to defer the capital gains taxes on the profits from selling the relinquished property.

The qualified intermediary must find the taxpayer a replacement property within 45 days of selling the relinquished property and complete the entire transaction in no more than a total of 180 days from the sale date.

Requirements for a Qualified Intermediary

Here are the requirements you should bear in mind when you want to hire a QI who handles 1031 exchanges professionally:

1. Neutrality and Independence From the Taxpayer: For a person or an entity to serve as your qualified intermediary in a 1031 exchange deal, they must not be related to you in any form, either by blood, marriage, or employment. As such, your attorney, real estate agent, investment banker, accountant, or anyone you’ve had a recent employment relationship with cannot be your QI.
2. Written Exchange Agreement: The fact that someone held the exchange proceeds of the sale of your real property and eventually bought a new one for you within a stipulated timeframe does not automatically mean you performed a 1031 exchange. The IRC mandates that the agreement must have signed paperwork as proof of the deal. Without this, you’ll be liable to pay the ensuing taxes from the deal immediately.
3. Fund Handling: A qualified Intermediary is saddled with the responsibility of handling, on your behalf, every fund involved in the transaction. If the sale proceeds of your asset are not enough to purchase the replacement property, you are to send the balance to them.If, on the other hand, the realized fund is more than the cost of the new real investment property, they may use the extra cash for repairs. They can send you the balance if there are no repairs and further expenses on the property. And you will pay tax on the balance you receive.
4. Timeline Compliance: The IRC has strict guidelines on how long the like-kind exchange must take—45 days to find a new like-kind asset and 180 days to complete the deal. A QI must be able to facilitate the deal within this period.
5. Qualified Holding: After purchasing, the final part of the deal is to transfer the title of the real property held by the qualified intermediary to the taxpayer. Once this is done, the 1031 exchange process is completed and the firm’s responsibility is exercised.

What Is a Title Company?

A title company is an entity that helps you to do due diligence, prepare title insurance and other necessary documentation, and cater for the successful transfer of property rights during the purchase or sale of real property. The firm has no business helping you seek investors or buyers for your real asset.

Rather, they are only concerned with the legal perspectives of the intended transaction. When you hire a title company to sell your asset, these are the major roles they will play:

• Title Search: The first significant thing a title company will do is to conduct a thorough title search on the property you want to sell. This is to ascertain that you’re the rightful owner of the property and there are no pending issues or claims tied to it. These issues often include, but are not limited to, unpaid tax liens, mortgages, and ownership disputes.
• Title Insurance: Once ownership is ascertained and every obvious claim has been resolved, the company will purchase a premium from a title insurance company for the asset. This coverage protects the potential buyer against liability arising from any previously undiscovered issues associated with the property.
• Escrow Management: When you finally get a buyer for the property, the company will provide an escrow for the real estate transaction. The company will hold the buyer’s funds and the seller’s property title, and exchange them once every requirement is met and documents are signed. This way, they successfully protect both parties from potential fraud.

Although title companies are expected to be fully independent, some are not. In fact, some real estate investors/agents own their respective title companies. Due to their affiliations, such companies may not offer you the absolute transparency and neutrality you deserve. That’s why you must conduct proper research when choosing title companies.

One way to do this is to ensure they are not funded in part or whole by any realty company or lender. Also, ensure that none of the company’s owners or management is associated with anyone or firm that may have privileged interests in any deal the title company conducts. Most importantly, work with only firms with an air-tight reputation.

Can a Title Company Be a Qualified Intermediary?

Yes, a title company can be a qualified intermediary in a Section 1031 like-kind exchange as far as its relationship with the taxpayer doesn’t automatically make it a “disqualified person.” According to the law, such a disqualified entity is anyone who has served as the taxpayer’s agent for tax purposes, real estate deals, and financial investments within the past two-year period.

It also includes the taxpayer’s employee, employer, and attorney within the same time frame. Beyond this, the company must be wholly independent and none of its owners, investors, or leadership must be a family relative of the taxpayer, either by birth, marriage, or adoption. Failure to adhere to these rules can lead to serious consequences, including immediate tax liabilities, fraud penalties, and criminal charges.

Pros and Cons of Using a Title Company as a QI

These are the advantages and disadvantages to consider before you decide on whether to use a title company as your QI:

Pros of Using Title Company as Your QI

One of the foremost benefits of working with title companies is their sheer familiarity with real estate deals, giving them a heightened advantage in protecting their customers from fraud and legal irregularities.

The second reason they are a good choice is convenience. Title companies give you the chauffeur experience, allowing you to relax while they do all the difficult tasks. From managing the barrage of paperwork in title searches to coordinating third parties for property inspections, they take care of everything involved in selling your property and procuring a new one.

The amazing thing about this is that when you compare the work-to-cost ratio, you will find that their services are often worth the fee. Also, some renowned title companies have a strong industry reputation to maintain and can go the extra mile to ensure their clients get the best experiences.

Cons of Using a Title Company as Your QI

Working with a title company affiliated with you, your attorneys, or any of your family or business associates puts you at risk of having your transaction outrightly disqualified. In which case you’ll be liable to various penalties.

Another downside of hiring title companies is the unfortunate potential of working with a double-faced team. Some title companies are funded by realtors and investors with conflicting interests in your property. If you’re unlucky to onboard such a financial institution, you may become a victim of shady deals and investments.

Additionally, not all title companies are experts in 1031 like-kind exchange deals even though they often list it among their service offerings. So, before you go all in, try to get customers’ reviews that ascertain their history of handling such transactions with the best results.

Furthermore, there is a limit to the legal and tax guidance you can get from them. This is because title companies are not financial advisors and may not give you all the support you need to make the best decisions.

Finally, choosing to work with them may expose you to unnecessary IRS scrutiny. The reason is that the IRS is increasingly watchful of the activities of title companies to prevent fraud. One wrong move is enough for the IRS to open a criminal investigation on your property deal and related activities.

How to Choose the Right Qualified Intermediary for Your 1031 Exchange

The first thing to bear in mind when choosing the right QI for your 1031 exchange is that you’re not short of options. Apart from title companies, other eligible firms can serve as your QI. For instance, you can easily opt for a specialized qualified intermediary firm, such as Universal Pacific 1031 Exchange, to facilitate the transaction.

In fact, such specialized firms are safer to work with, have better 1031 exchange experience, and attract less IRS scrutiny. For the best result, here is how to find the right QI for your deals:

• Review different candidates and zero down on the ones with an impeccable reputation and laudable experience in handling such deals.
• Do proper checks on their founders, investors, and leadership to prevent conflict of interests.
• No matter how tempting it may be, ensure no one at the company has any financial or familial ties with you.
• Ensure they have the right legal and compliance framework to handle 1031 exchange transactions.

Alternatives to Using a Title Company

There are several alternatives to using a title company, top of which are as follows:

Professional Qualified Intermediary Firms

As the name suggests, these firms specialize in performing the role of QI in 1031 like-kind exchanges. Unlike title companies who often offer a myriad of services, including title and escrow, professional QI firms are niched down with sheer understanding, experience, and mastery of the complexities of the 1031 exchange process. 

They abide by stringent IRS regulations to ensure transparency and compliance with the requirements for qualified exchanges. In terms of security, professional QI firms often keep funds for real estate transactions in separate accounts, something not usually done by their counterparts. Amazingly, all these benefits, including professional advice and guidance, come at cheaper fees than what is obtainable from title companies.

Attorneys or Escrow Companies That Meet IRS Qualifications

Attorneys who don’t have any affiliations with you can also serve as alternatives to title companies as long as they meet the necessary IRS requirements. This has its perks as they can offer clients legal advice at the right fee. Escrow companies, too, can serve as QI, but you must endeavor to do proper research when choosing, as some of them aren’t qualified to handle this responsibility.

Looking for a Qualified Intermediary for Your 1031 Exchange?

Any investment firm such as a title company can handle a 1031 exchange as a qualified intermediary as long as they meet the eligibility requirements of the IRS. Hiring one for your exchange has its pros and cons that you should study properly before making a decision.

However, a 1031 exchange doesn’t have to be a hassle. More importantly, you don’t have to suffer liabilities or penalties due to your QI mistakes. If you need a reliable qualified intermediary with a proven track record to handle your 1031, Universal Pacific 1031 Exchange is your sure bet. 

Irrespective of your location in the United States, you can rest assured that we will handle your business with the documented professional standards and priority. Contact us now to start a 1031 exchange.