31 C.F.R. 1031.320(b)(2)(vii)
Exemption: Transfer to Qualified Intermediary (1031 Exchange)
When property is transferred to a qualified intermediary as part of a tax-deferred 1031 exchange, that specific transfer leg may be exempt.
Rule text summary
The rule exempts a transfer to a qualified intermediary in a transaction structured as a like-kind exchange under Internal Revenue Code Section 1031. The exemption applies to the transfer to the intermediary, not necessarily to all legs of the exchange.
Paraphrased for clarity. See the Federal Register Final Rule for authoritative text.
Analysis
In a 1031 like-kind exchange, a property owner sells one investment property and uses the proceeds to buy another, deferring capital gains taxes. A qualified intermediary holds the proceeds between the sale and the purchase. The transfer of the relinquished property to the intermediary (or the intermediary's role in the transaction) can qualify for this exemption.
The important nuance is that this exemption applies to the transfer to the qualified intermediary, not to the entire exchange chain. The subsequent purchase of the replacement property by the taxpayer's entity may still be a separate reportable transaction if it meets the other triggering conditions (entity buyer, non-financed, residential property). Each leg of the exchange needs independent analysis.
Practical guidance
- Obtain the executed qualified intermediary agreement and confirm that the intermediary meets the definition under IRC Section 1031 and related Treasury Regulations.
- Map the exemption to the specific transaction leg that involves the transfer to the intermediary. Do not assume all legs of the exchange are automatically exempt.
- Analyze the replacement property acquisition independently. If an LLC acquires the replacement property with exchange funds (not a bank mortgage), that acquisition may itself be reportable even though the relinquished property transfer was exempt.
- For reverse exchanges, deferred exchanges, or build-to-suit exchanges with custom structures, escalate to counsel. Non-standard exchange structures may not fit cleanly into this exemption.
Common mistakes
- Assuming that a 1031 exchange exempts all transfers in the chain. The exemption is for the transfer to the qualified intermediary. Other legs require independent analysis.
- Failing to preserve the intermediary agreement and exchange documentation. Without these records, you cannot support the exemption claim.
- Applying the exemption when the exchange structure does not actually involve a qualified intermediary, such as a direct swap between two parties without an intermediary.