Qualified Intermediary Due Diligence: Protecting Your 1031 Exchange Strategy

In real estate investing, the 1031 exchange is a powerful tool. But as with any strategy that involves significant assets and IRS rules, the details matter. One of the most important details in a 1031 exchange is choosing the right Qualified Intermediary (QI).

A QI is an administrator of 1031 exchanges. They are entrusted to hold exchange funds and correctly prepare essential documentation. Yet unlike banks, trust companies, or registered investment advisors, QIs are largely unregulated. That makes due diligence not just smart, but essential.

Why Qualified Intermediary Due Diligence Matters

Without a qualified, trustworthy intermediary, investors run the risk of:

• Loss of Funds: In extreme cases, fraud or mismanagement has led to investors losing millions in 1031 exchange proceeds.

• Disqualified Exchanges: Errors in documentation or timing can invalidate the 1031 exchange, triggering a large and unexpected tax bill.

• Disruptions or Delays: Operational inefficiencies may cause frustration and even missed deadlines, which may put the exchange in jeopardy.

When you hand over your proceeds from a sale, you are not just trusting the QI with your money, you are trusting them with your tax deferral strategy and long-term financial goals.

Key Areas to Evaluate in a 1031 Exchange Qualified Intermediary

Not all QIs are created equally. Here are the core areas investors should consider when vetting an intermediary:

1. Financial Safeguards. Ask how client funds are held. Are they kept in separate, segregated accounts, or commingled with other clients’ money? Are they FDIC insured? The more transparent and secure the structure, the better protected you are.

2. Compliance and Documentation. A good QI will provide clear, accurate exchange agreements and ensure that all IRS timelines are tracked and met. Sloppy paperwork is a red flag.

3. Experience and Track Record. Look for a QI with decades of experience. Ensure the QI is well-versed in handling exchanges of different sizes and complexities. Ask about their experience: How many exchanges do they handle annually? How long have they been in business?

4. Operational Integrity. What controls are in place to ensure your transaction will run smoothly? Does the QI work with legal and tax advisors when needed? Is your QI also a tax attorney?

5. Transparency and Communication. 1031 exchanges involve tight deadlines and multiple parties. A reliable QI will be responsive, accessible, and clear in their communication.

Questions to Ask Before Choosing a QI for Your 1031 Exchange

When conducting due diligence, consider asking questions that go beyond the basic understanding of IRS rules:

• How are 1031 exchange funds held and protected?

• What insurance or bonding do you carry?

• Can they provide references or case examples?

• What internal controls prevent errors or fraud?

The goal is to confirm that you are working with a professional who values transparency and accountability as much as you do.

The Bigger Picture: Trust, but Verify

A 1031 exchange can fuel long-term wealth building without the drag of unnecessary taxation. But the wrong QI can turn that opportunity into a costly mistake. By taking the time to vet your QI with the same rigor you apply to your investments, you are protecting not just your money, but your future.

Due diligence is not about distrust; it’s about building a foundation strong enough to leave no room for mistrust.

If you are considering a 1031 exchange, feel free to call me, Jeff Peterson, at 612-643-1031, or email me at jeffp@CPEC1031.com.

Defer the tax. Maximize your gain.

© 2025 Copyright Jeffrey R. Peterson All Rights Reserved

Can You Use a 1031 Exchange for Profits from Real Estate Development?

At first glance, a 1031 exchange might seem like a smart way to reinvest proceeds from the sale of developed real property, especially if you are planning to roll those profits into your next project. But the IRS draws a line between real estate being held for investment or business purposes and real estate held primarily for sale.

A Real-World Scenario

A developer recently posed this thoughtful question:

“We developed a 20-unit condominium complex. Twelve units have been sold, and the proceeds paid down our construction loan. We have since paid off the balance and have some net proceeds. The last eight units will soon sell. Can we roll all (or some) of the proceeds from these final sales into a new parcel of land for development using a 1031 exchange?”

This is a great question and the answer is: it depends on the specific facts and circumstances.

Why All Real Estate Doesn’t Qualify for 1031 Exchange

When real estate held for investment or productive use in a trade or business is exchanged for like-kind property, Section 1031 of the Internal Revenue Code allows for the deferral of capital gains tax.

However, property held primarily for sale, such as property developed with the intent to sell to customers, is excluded from 1031 treatment.

This is spelled out in IRC §1031(a)(2):

“This subsection shall not apply to any exchange of real property held primarily for sale.”

In short: if your property is considered “inventory” in the eyes of the IRS, rather than held for investment, 1031 tax deferral is not an option.

How the IRS Determines “Held for Sale”

Courts look at a variety of factors to make this call, including:

1. Why you acquired the property

2. How long you held it

3. What improvements you made

4. The number, frequency, and permanency of sales

5. The scale and substance of your transactions

6. The nature of your business

7. Whether you marketed the property

8. Whether you used brokers or listing services

(Cited cases include Mathews v. Commissioner, 315 F.2d 101 (6th Cir. 1963) and Gardner v. Commissioner, T.C. Memo. 2011-137.)

If your activity looks more like a development business rather than long-term investment holding, the IRS may view the property as held for sale even if you only develop occasionally.

Development Projects and the “Dealer” Trap

In our condo example, the developer created a project with the intent to sell individual units. That’s a red flag for the IRS. Paying off a construction loan, profiting from individual unit sales, and rolling the gains into new land for further development mirrors the activities of a property dealer, not a long-term investor.

While it’s possible that some portion of the project might qualify, it’s a gray area that could lead to an audit or challenge. This is why consulting a qualified tax advisor early in the process is essential.

See if Your Property Qualifies for 1031 Exchange

1031 exchanges are powerful tools, but not all real estate deals qualify. If you are a developer or builder looking to defer taxes on your next project, it is important to understand the IRS rules and how your specific facts stack up.

When in doubt, get professional advice. Every situation is unique, and your tax advisor can help you evaluate your eligibility and avoid costly surprises.

• Thinking about a 1031 exchange? Feel free to call me, Jeff Peterson, at 612-643-1031, or email me at jeffp@CPEC1031.com.

Defer the tax. Maximize your gain.

© 2025 Copyright Jeffrey R. Peterson All Rights Reserved     

Video – Important Players in a 1031 Exchange: CPA or Accountant

At CPEC1031, LLC we are great qualified intermediaries who can facilitate the mechanics of your 1031 exchange. However, we’re only allowed to wear one hat in the exchange – that of the neutral unbeholden third party. There are a lot of other people that you may need at some point in the process to help you make an informed decision and to have the necessary inputs for a successful 1031 exchange.

Many times, taxpayers need to bring their existing accountant or tax advisor into the decision making process. Your accountant is going to know what the depreciation schedule is on the old property. They’re going to know what your remaining basis is. Basis is critical in a 1031 exchange because your gain is not how much cash proceeds you walk away with, but rather the difference between your current adjusted basis and the net selling price. So even though you walk away from closing with little or no cash proceeds, you may have an enormous gain because your basis may have been whittled down over years of depreciation.

Your accountant is critical in helping you make an informed decision. Without your accountant, your transaction is like an airplane that doesn’t have any instrumentation.

Your Like-Kind Exchange Resource – CPEC1031, LLC

The qualified intermediaries at CPEC1031, LLC are your go-to resource for all things related to section 1031 of the Internal Revenue Code. Our team is ready and waiting to guide you through the like-kind exchange process from beginning to end, ensuring that you are comfortable and well-informed every step of the way. Reach out to us today to learn more about the 1031 exchange process and see how you can save money with a 1031 exchange by reinvesting into a bigger, better replacement property.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2025 Copyright Jeffrey R. Peterson All Rights Reserved

PIGs (Passive Income Generators): A Smart Strategy for Unlocking Passive Income and Building Wealth

In the world of real estate investing and tax planning, there is a saying worth remembering: “Pigs get fed, hogs get slaughtered.” When it comes to generating passive income and making the most of your passive losses, it pays to be the right kind of pig: a Passive Income Generator, or PIG.

Why Passive Income Matters

Passive income is the dream: money that shows up whether you are laboring or not. But in the tax world, the IRS has its own definition and a strict set of rules about what counts as passive activity and how losses can be used.

Back in 1986, the Reagan administration rewrote the rules with the Passive Activity Loss (PAL) limitations, designed to shut down abusive tax shelters. The result? The losses from passive investment activities can only be used to offset the income from other passive investment activities. That’s where PIGs come in.

The Problem: Trapped Losses

Real estate investors often find themselves with passive losses they cannot use, at least not immediately. Unless your income is under certain thresholds, or you qualify for one of the key exceptions, those losses just sit there.

Here are the three most common paths to unlock those losses:

1. The $25,000 Passive Loss Allowance: For rental property owners under certain income limits, this exception allows up to $25,000 of losses to be used against non-passive income.

2. Real Estate Professional Status (REPS): Qualifying as a real estate professional allows you to treat rental activities as non-passive, but the requirements are strict and well-documented.

3. Short-Term Rental (STR) Loophole: If your average rental stay is 7 days or less, and you materially participate, those rentals may be treated as non-passive, even without REPS status.

But what if none of these apply?

The Strategy: Find a PIG

Enter the Passive Income Generator (PIG), an investment that produces income without material participation. When the income is passive, it can unlock the value of your passive losses.

Think of a PIG as a tool in your wealth-building toolbox. It does not reduce your taxes on its own but when paired with existing passive losses, it can create meaningful tax savings and improved after-tax cash returns.

What Qualifies as a PIG?

Not all “hands-off” investments qualify as passive under IRS rules. Here are some examples that do qualify:

• Real Estate Limited Partnerships (RELPs): You invest capital, receive distributions, and leave the operations to someone else.

• Rental Properties (when the management is outsourced): If you are not materially involved, your income is passive.

• Private Equity Real Estate Funds: These funds are designed for limited partner investors, providing income and potential appreciation without active participation.

• Peer-to-Peer Lending: Returns from P2P platforms can generate passive income in the form of interest.

On the other side of the spectrum, here are a couple of examples that do not qualify as passive investments under IRS rules:

• Dividend Stocks, Real Estate Investment Trusts (REITs) or Capital Gains: While they may feel passive, this is technically portfolio income, and it cannot be used to offset passive losses. Under Treasury Regulation §1.469-2T(c)(2 & 3), portfolio income is not considered income from passive activity and that includes interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business.

• Your Own Business (if you materially participate): Even if you are not grinding it out every day, your involvement may still be deemed active under IRS rules.

Use Caution, Not Just Optimism

A true PIG isn’t just a tax strategy; it is an investment. That means due diligence is critical. Before jumping in, ask:

• How much income will this realistically generate?

• What’s the risk profile?

• What’s the liquidity and redemption policy?

• Does the tax benefit justify this investment?

The goal isn’t just to feed your losses; it is to feed your future wealth.

PIGs and the Bigger Picture

Finding and funding a PIG is a strategic move for investors who have already done the hard work of building a portfolio and accumulating passive losses. When used wisely, PIGs can accelerate your returns and reduce your tax liability without requiring you to qualify as a real estate professional or convert to short-term rentals.

But don’t forget the bigger picture: a good PIG should stand on its own as a solid investment. The tax benefit is icing on the cake, not the cake itself.

Think Like a Strategist

When it comes to wealth building, passive income plays a powerful role, but the IRS rules mean it is not as simple as “make money while you sleep.” Understanding the role of PIGs, and how to unlock passive losses with passive income, can make all the difference in your long-term strategy.

Think carefully. Choose wisely.

• If you are considering a 1031 exchange, feel free to call me, Jeff Peterson, at 612-643-1031, or email me at jeffp@CPEC1031.com.

Defer the tax. Maximize your gain.

© 2025 Copyright Jeffrey R. Peterson All Rights Reserved

Qualified Intermediaries: Why You Need One for Your 1031 Exchange

A qualified intermediary is an important element in any 1031 exchange of real estate. In this article, we are going to explain the role of the qualified intermediary and discuss why you need one for your 1031 exchange of real estate.

The Importance of a Qualified Intermediary

There are many important professionals you want to have on your team when embarking on a 1031 exchange of investment real estate. You should involve your CPA or accountant, your attorney, your real estate broker, a good title company – just to name a few. Perhaps the most important professional you want to engage in a 1031 exchange is a qualified intermediary. A qualified intermediary (or QI for short) is a professional that specializes in the facilitation of like-kind exchanges under section 1031 of the Internal Revenue Code.

Your qualified intermediary can guide you through the 1031 exchange process – making sure you understand all the rules and benchmarks that you need to satisfy in order to defer your capital gains taxes. They can also help prepare important documentation during the exchange. The most important role that a QI plays is that of a neutral third-party that insulates the taxpayer conducting the exchange from receiving any of the net proceeds from the sale of the relinquished property. Taking constructive receipt of any sales proceeds would trigger taxable boot (and thus result in a partial or failed exchange). Your intermediary holds the funds on your behalf and then reinvests them into the replacement property so you can defer 100% of your capital gains taxes.

Call a Qualified Intermediary at CPEC1031, LLC to Start Your Exchange

Interested in learning more about the tax-saving potential of a 1031 exchange? Call a qualified intermediary at CPEC1031, LLC today to start the exchange! We have more than twenty years of experience working with taxpayers across the United States on 1031 exchanges of all types (forward, reverse, build-to-suit, etc.) and we can help you through the details of your like-kind exchange. You can find us at our primary Twin Cities office located in downtown Minneapolis.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2025 Copyright Jeffrey R. Peterson All Rights Reserved