Most Section 1031 like-kind exchanges of real property rely on “qualified intermediaries” to hold the proceeds from the sale of the taxpayer’s original property while the taxpayer locates suitable replacement property. The taxpayer is required to identify his replacement property within 45 days of the sale of his original property and then must close the purchase of the replacement property within 180 days of the sale of his original property. When the IRS issued regulations permitting these “deferred” exchanges, it gave birth to a new cottage industry of “exchange accommodators” or “qualified intermediaries,” as they are known under the tax regulations.
Many, if not most, exchange accommodators are highly reputable companies. A number of them are subsidiaries of banks or title insurance companies. However, as in any industry, there are always a few bad apples. Some disreputable individuals owning exchange intermediary companies have absconded with the exchange funds the company was holding and then put the company into bankruptcy. These actions gave rise to the tax question of what happens to the taxpayer who was trying to complete a Section 1031 exchange but was unable to do so because his accommodator ran off with the money? Is his original sale now taxed in full because he failed to close the purchase of his replacement property within 180 days?
The IRS has continued its generous interpretation of IRC Section 1031 by issuing a revenue procedure which grants relief for taxpayers in this predicament. Rev. Proc. 2010-14 provides that if a taxpayer qualifies for relief under the procedure, he will only recognize proportionate amounts of gain when, and if, he recovers anything from the accommodator or its bankruptcy estate. A taxpayer may only rely on this safe harbor if his accommodator went into a bankruptcy proceeding under the United States Code or a federal or state receivership proceeding. If your accommodator simply took off with your money and never ended up in court, you apparently cannot rely on the revenue procedure.
In prior articles we have cautioned our readers to perform appropriate due diligence on exchange accommodation companies they are considering using. We continue to be surprised by the number of otherwise sophisticated people who are willing to have substantial sums held for up to 180 days by companies with respect to which they know virtually nothing. Please do your homework and do not allow yourself to be put in a position where you need to rely on Revenue Procedure 2010-12.