The Qualified Intermediary's Role in a 1031 Exchange

Section 1031 defers tax on an exchange of like-kind property, not on a sale followed by a separate purchase. If the investor receives the sale proceeds directly, even for a single day, the transaction functionally becomes two independent events in the eyes of the IRS: a taxable sale and an unrelated purchase. The qualified intermediary exists to break that chain by holding the proceeds in escrow between the two closings, so the investor never has actual or constructive control over the money during the exchange period.

The IRS created a safe harbor allowing investors to use a qualified intermediary without that arrangement itself being treated as constructive receipt, provided the intermediary meets specific independence requirements and the exchange agreement restricts the investor's rights to the funds. Without this safe harbor, any use of a third party to hold proceeds could arguably still count as receipt by the investor. Michigan investors relying on the safe harbor need the exchange agreement drafted correctly from the start, since a poorly worded agreement can undercut the very protection the safe harbor is meant to provide.

The IRS disqualifies certain parties from serving as QI specifically because their existing relationship with the investor could give the investor practical control over the funds. Disqualified parties generally include:

• the investor's employee, attorney, accountant, or real estate agent within the two years before the exchange
• any relative of the investor by blood or marriage
• any entity in which the investor holds a significant ownership interest
• a bank or title company already serving as the investor's agent in the transaction

Constructive receipt does not require the investor to actually take the money. It only requires that the investor had the ability to demand or direct the funds, whether or not they exercised that ability. A closing agent asking whether a seller wants a wire or a check, and the investor answering that question directly instead of the QI, can create a constructive receipt problem even if no money physically changed hands. Michigan exchanges involving smaller or rural closing offices unfamiliar with exchange procedure are more exposed to this risk simply because the closing team may not automatically route every proceeds-related question to the intermediary.

Beyond holding funds, a qualified intermediary prepares the exchange agreement, receives the written identification notice within the 45-day window, coordinates assignment of the purchase and sale agreements, and disburses funds directly to the closing agent for the replacement property. Choosing a QI with real experience closing Michigan transactions matters because local closing customs vary meaningfully between a high-volume Wayne County title office and a smaller closer in a less populated county, and an intermediary unfamiliar with those differences can slow down an already time-sensitive process.

Not every company offering intermediary services carries the same level of insurance, bonding, or operational experience, and the industry has seen failures where an intermediary misused or lost client funds before an exchange completed. Michigan investors are generally better served asking a handful of direct questions before committing: how client funds are held, whether the funds are commingled with the intermediary's operating accounts or other clients' exchange proceeds, what fidelity bond or errors-and-omissions coverage is carried, and how many exchanges the company closes in a typical year involving Michigan property specifically. An intermediary that primarily works exchanges concentrated in a single state and has limited Michigan closing history may be less familiar with local title customs than one that regularly closes transactions across Detroit, Grand Rapids, and the smaller counties in between.

It is also worth confirming, in writing, how quickly the intermediary responds during the identification window, since a slow reply during those 45 days can compress an already tight deadline for reasons that have nothing to do with the underlying real estate.