Considerations for No Fee 1031 Exchanges

A 1031 Exchange innately is a tax deferral strategy, not an investment vehicle. The goal of a 1031 Exchange is to achieve tax deferral on qualifying real estate transactions, in turn increasing cash flow and reinvestment potential, which, over time, compounds into greater returns on investments.

Role of a Qualified Intermediary  

A Qualified Intermediary (QI) exists to facilitate a 1031 Exchange by acting on behalf of the parties, so the transaction is not merely a sale followed by a purchase, but rather, an actual exchange of one property for the other. The main goal of a Qualified Intermediary is to help an Exchanger achieve tax deferral by abiding by the rules and regulations set forth in the subject Treasury Regulations. These rules are detailed and complicated to navigate. Therefore, it should be of no importance to the QI how long it takes an Exchanger to identify and acquire the Replacement Property, as long as it falls within the allotted time frame. A Qualified Intermediary with no initial exchange fee is reliant on exchange funds sitting close to the 180-day exchange period deadline, as they only gain revenue during the time they hold an Exchanger’s exchange funds.  

There are two questions that arise when a QI only receives monetary compensation on the basis of the length of time that they are holding Exchange Funds. First, whether that sole revenue stream is enough to maintain operational controls to protect your investment. And second, is there the right economic incentive to ensure you receive the ongoing service post-exchange if funds were only held for a very short duration?   

The Cost of a 1031 Exchange  

For a 1031 Exchange, the initial fee covers a multitude of aspects including 4 specific categories:

Specialized 1031 Experts  

“You get what you pay for,” is a widely known saying for a reason – it is true. As a QI looking to provide the utmost service to its clients, there is often staff consisting of highly credentialed personnel including specialized 1031 attorneys, CPAs, and Certified Exchange Specialists®. While these persons do not provide legal or tax advice their depth of experience can be invaluable. 

Segregation of Duties 

Reputable QIs are staffed to scale, they have numerous team members that specialize in specific areas of a 1031 Exchange to ensure accuracy, prevent mistakes, and maintain accountability. Internal controls are set up to protect the Exchanger’s Personal Identifiable Information (PII), as well as create efficient processes that are not dependent on any one specific team member.  

Industry Leading Technology 

There is software available within the industry including patented 1031 Exchange workflow technology, Exchange Manager Pro^SM, utilized to date by over 30 national QIs, including the nation’s third largest publicly traded QI. Exchange Manager Pro^SM includes SOC 2 Type II compliance, secure data storage through Microsoft Azure, and automated document creation and deadline notifications reducing potential for human error and helping maintain compliance with IRC §1031. These technologies are costly but provide benefit to the Exchanger and the QI. 

While the prospect of a no cost 1031 Exchange, might be seem appealing at first glance, decades of experience has taught us that when a significant portion of someone’s wealth is at play, they prefer to pay a nominal fee for security and confidence in the QI.  

Security and Liquidity of Exchange Funds 

The QI also holds exchange funds to avoid actual or constructive receipt by the Exchanger. It’s important for the QI to maintain coverages and follow specific guidelines to ensure the safety and security of Exchange Funds. As an example, some standard guidelines that they must follow are, holding funds in segregated banks accounts, maintaining adequate coverages for a fidelity bond, errors & omissions policy, and cyber liability policy.    

Some additional measures taken by only the leading QIs, that are of absolutely importance to the integrity of the exchange and safety of the exchange funds include:  

• Utilizing only 4- and 5-star Bauer rated depository banks 

• Segregated accounts opened under the Exchanger’s SSN or EIN to ensure that should the QI file for bankruptcy it is abundantly clear the funds are not that of the company, but of the individual Exchanger  

• Exchange funds held in liquid, demand deposit accounts, available for client direction of acquisition for Replacement Property at any time  

• Controls against Exchange disbursement directions being submitted fraudulently 

• Dual authorization and verbally confirmed wire instructions 

  
  

Under a traditional fee-for-service model, the QI is motivated only to focus on facilitating a successful tax deferral, not on the duration that they are holding your exchange funds. Here, an Exchanger can rest assured their exchange funds are being held in their best interest with less of an incentive to reach for revenue by potentially putting Exchanger funds at risk.   

For over 100 years, since 1921, 1031 Exchange have been in the US Tax Code. The QI was introduced in the 1991 Regulations. Since then, the general business model has included an initial fee to start a 1031 Exchange with the ultimate goal of the QI helping achieve tax deferral for the Exchanger.  

Aggregated industry data for 2024 shows that for a standard forward exchange, the exchange fee is nominal, roughly just .05% of the average Relinquished Property Contract Price per exchange. For real estate investors that may have anywhere from 10-50% of their total wealth tied up in real estate investment, that exchange fee is well worth the assurance that their 1031 Exchange is in capable hands, with measures to protect the overall integrity of the exchange, and their exchange funds.  

1031 Asset Solutions has dedicated specialist to help with your inquiries about no fee exchanges. Give us a call today at 844-401-1031.