IRC Section 1031

Under IRC Section 1031 and the deferred exchange regulations, a taxpayer can defer taxes by selling his relinquished property and acquiring replacement property at a later date, and provided that all of the rules are followed, the transaction is considered an exchange rather than a sale followed by a purchase.  For this to happen, the taxpayer cannot have actual or constructive receipt of the proceeds from the sale (the “exchange funds”).    

Constructive Receipt

The taxpayer does not have to actually take possession of the exchange funds after the relinquished property closes to create a problem.  If any of the taxpayer’s agents take possession of the exchange funds, the taxpayer can be considered to have constructive receipt of the funds, and the exchange could be compromised.  An attorney who has represented the taxpayer on matters other than exchanges within the two-year period before the closing of the relinquished property would be considered an agent of the taxpayer.    

A common solution to this problem is to have the attorney continue to act as the closing agent, but have the purchaser send the exchange funds directly to the qualified intermediary who is handling the exchange.   Another option may be to have the title insurance underwriter or an attorney who is not an agent of the taxpayer handle the receipt and disbursement of the funds. 

Can my Attorney be my Qualified Intermediary?

A separate, but related, question is whether a taxpayer’s attorney may act as the intermediary in his exchange.  The IRS rules provide that an attorney cannot act as a qualified intermediary for a client if the attorney has performed services for the client any time during the two year period ending on the date the relinquished property closes, unless those services are limited to the client’s 1031 exchange.  

A cautious attorney will consider alternatives before handling funds on either side of his client’s exchange transaction and will seek the assistance of a qualified intermediary instead of attempting to represent his client in that capacity.  At First American Exchange, we can help find solutions to these and other issues that often come up in a taxpayer’s exchange.  Please contact us if we can be of assistance. 

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Reminder: Did You Start a 1031 Exchange Between October 20 and December 31, 2011?

In a 1031 exchange, the taxpayer must acquire all replacement property by the earlier of the date that is 180 days from the date the relinquished property closes, or the date the taxpayer’s federal income tax return is due, including extensions.  This means that for exchanges where the relinquished property closes late in the year, the calendar-year taxpayer may need to get an extension of the tax filing deadline in order to benefit from the full 180-day exchange period.

For example, if the taxpayer is an individual who closes the sale of his relinquished property on December 1, 2011 and he does not get an extension, he will only have until April 17, 2012 to acquire all replacement properties.  If he gets an extension, however, he will have until May 30, 2012 to acquire all replacement properties.  For corporations on a calendar-year tax basis that close their sale late in the year and do not apply for an extension, they will only have until March 15, 2012 to complete their exchange.  Even though the granting of the extension is “automatic” remember that you must still file with the IRS to claim it.  (Form 4868 for individuals) 

Once a tax return is filed, it cannot be amended to include the exchange or to obtain an extension of time to complete the exchange. If the exchange is incomplete, the sale will need to be reported as a taxable event.