Qualified Intermediary

As part of a Section 1031 exchange, the qualified intermediary's fee and standard closing costs are paid directly out of the exchange proceeds it is holding, rather than the investor paying them separately out of pocket. Does using exchange proceeds this way create boot?

1. A.Yes -- any use of exchange proceeds for something other than purchasing the replacement property itself is boot, without exception.Wrong. Customary exchange-related expenses paid from the proceeds are a recognized exception, not treated as boot.
2. B.Yes, but only the intermediary's fee is boot; standard closing costs are never treated as an issue regardless of how they are paid.Wrong. Both categories are generally treated the same way as non-boot exchange expenses; this invented distinction is incorrect.
3. C.Generally no -- customary transactional expenses of the exchange itself, such as the intermediary's fee and standard closing costs, paid from the exchange proceeds, are not treated as boot, unlike using those same proceeds for some other, non-exchange purpose.Correct. Customary exchange expenses paid from proceeds are not treated as boot.
4. D.No, but only if the investor first receives the proceeds directly and personally pays the expenses out of her own funds.Wrong. This describes the opposite of what protects the exchange; direct receipt of proceeds by the investor is what jeopardizes it.

Why: Customary transactional expenses of the exchange itself, such as the intermediary's fee and standard closing costs, paid from the exchange proceeds, are generally not treated as boot, unlike using those same proceeds for some other, non-exchange purpose.

An investor sells her relinquished property and has the sale proceeds deposited directly into her own personal bank account before using those funds to purchase replacement property a few weeks later. Does this transaction qualify for Section 1031 deferral?

1. A.Yes, as long as the replacement property is purchased with those same funds and is like-kind to the relinquished propertyWrong. Using the same funds for a like-kind replacement property does not cure the problem of the investor having directly received and controlled the proceeds.
2. B.Yes, because Section 1031 has no requirement about who holds the sale proceeds, only about the character of the properties exchangedWrong. Section 1031 does require that the investor not directly receive or control the exchange proceeds.
3. C.No, but only because personal bank accounts are ineligible; the exchange would qualify if the proceeds were instead deposited into a business bank account she controlsWrong. The problem is her control over the funds, not the type of account; a business account she controls would raise the same issue.
4. D.No, because the investor's direct receipt and control of the sale proceeds disqualifies the exchange; proceeds generally must be held by a qualified intermediary rather than received by the investorCorrect. Direct receipt or control of the proceeds by the investor disqualifies the exchange; proceeds must generally pass through a qualified intermediary.

Why: Direct receipt or control of the exchange proceeds by the taxpayer defeats the exchange, regardless of whether the properties themselves are like-kind. Proceeds generally must be held by a qualified intermediary rather than received by the investor.