To meet the requirements of the Qualified Intermediary (QI) safe harbor, there must be a written exchange agreement between the Taxpayer and the QI. The agreement must be executed at or before the closing of the relinquished property.
Both the relinquished property and replacement property contracts must be assigned to the QI. The relinquished property purchaser and the replacement property seller must have notice that the Taxpayer's contract rights have been assigned. It is a good idea to attach a rider to the contract with language to require the parties to participate in the exchange. There is no additional risk to the non-exchanging purchaser/seller under a ยง 1031 exchange.
The QI does not take title to the real estate. The regulations allow the property to be deeded directly between the respective parties.
The net proceeds of the sale of the relinquished property go directly to the QI, to prevent actual or constructive receipt of the proceeds by the Taxpayer.
The earnest money deposit for the replacement property may come from the proceeds held by the QI. The Taxpayer should issue a letter of direction to the QI, including the reason for the disbursement of funds and the method of delivery. The replacement property contract must be assigned to the QI before any earnest money may be withdrawn from the escrow. The QI cannot directly reimburse the Taxpayer for any earnest money deposit made by the Taxpayer.
When it is time for the closing on the replacement property, the Taxpayer must make a written request for the transfer of exchange proceeds to the closing agent. The proceeds are never made payable to the Taxpayer.
See article below for information on recommended language to include in real estate contracts.
Recommended Real Estate Contract Language for 1031 Exchanges [1]
Links:
[1] http://firstexchange.com/content/real-estate-contract-language