In the 1031 exchange industry, a trustee is a party who holds the title to a property on behalf of the beneficial owner during the exchange process. In these transactions, the term Qualified Intermediary (QI) is more commonly used than trustee. However, the role they play can be similar in that they are both third parties entrusted with certain responsibilities and obligations.
A 1031 exchange allows an investor to defer capital gains taxes on the sale of a property used for business or investment if the proceeds are reinvested in a like-kind property. The Qualified Intermediary or trustee is crucial to this process, performing the following roles:
- Facilitator: The QI facilitates the 1031 exchange by holding the sale proceeds of the relinquished property to ensure the process adheres to IRS regulations. The QI cannot be someone who has acted as the taxpayer’s agent or advisor within the two years preceding the transaction (there are exceptions for routine financial, title insurance, escrow, or trustee services).
- Documentation: The QI prepares the legal documents necessary for the 1031 exchange, such as the Exchange Agreement, assignment of the sale contract to the QI, and the identification of replacement property.
- Transacting: The QI receives the sale proceeds from the relinquished property and uses those funds to purchase the replacement property. The taxpayer (property owner) never takes actual or constructive receipt of the funds during the exchange process, which would trigger a taxable event.
- Oversight: The QI holds the funds in a secure account and manages the timing and logistics of the funds transfer to the seller of the replacement property.
- Reporting: After the transaction is complete, the QI provides detailed accounting for the transaction to the taxpayer and the IRS.
In some cases, an exchange accommodation titleholder (EAT) may be used in more complex 1031 exchanges, like reverse or improvement exchanges. An EAT is a type of trustee that holds the legal title to the replacement property before the exchange is completed.
It’s important to note that a trustee in a 1031 exchange, or more accurately a QI, must be an independent entity that does not have a disqualifying relationship with the taxpayer. This independence ensures the transaction is treated as a valid exchange for tax-deferral purposes.