When you are doing an exchange it is important to understand that federal tax regulations limit your rights to receive, pledge, borrow, or otherwise obtain the benefits of the money held by the intermediary during the exchange period. Once your relinquished property has closed and the qualified intermediary is holding the exchange proceeds, these rules permit them to use the funds to acquire replacement property and to release any remaining funds as follows:
- If you have not identified replacement property during the 45 day identification period, you may receive the funds as of the 46th day.
- If you have identified replacement property, you may receive the funds as of the sooner of (a) the date that you acquire all replacement property that you have identified and (b) the end of the 180 day exchange period. In other words, if you identify more than one property but you don’t acquire all of them, the intermediary must retain the balance of the funds until the 181st day.
- Another condition may permit you to get control of the exchange funds before the 181st day, but it is very limited. The regulations say that if a material and substantial contingency occurs that relates to the exchange, is provided for in writing and is beyond the control of the investor and any disqualified person other than the seller, then the funds may be delivered to the investor before the 181st day. Although this regulation appears to give you more leeway, the IRS has ruled otherwise. The IRS has stated that a “material and substantial contingency” occurs when the event is truly out of the control of the investor, such as where the property is destroyed in a fire or condemned, or where a zoning change request which was a condition of acquiring the property was denied, or something substantially similar. These are very limited reasons which may permit us to release the funds early.
What does this mean for you when you are planning your exchange? You should plan for the possibility that your exchange funds may not be available until the 181st day, if you don’t acquire all identified properties, or even if you are unable to acquire any identified properties and therefore have a failed exchange. In both of these instances, the intermediary has to hold the balance of the funds until the end of the exchange period. In addition, if you don’t identify any properties, the intermediary must hold the funds from the sale of the relinquished property until the end of the 45-day identification period.
These rulings underscore the importance of carefully planning your exchange. Some practical tips include:
- If you know you would like to use only a portion of the equity from a relinquished property in the exchange, have escrow transfer directly to you the portion that will not be a part of the exchange, with only the balance going to the intermediary. If you do this, you will pay tax on the amount you receive, and in some states there may be withholding on the amount sent to you, but you will have your money immediately.
- If you have identified properties but decide not to do an exchange, and you are within your 45-day identification period, revoke your identification and you should be able to receive the money on the 46th day, rather than on the 181st day.
Planning your exchange will help you have a successful tax-deferred transaction with no surprises.
Disclaimer: This information is of general nature and should not be assumed to provide tax, legal or accounting advice. This website has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. I will be happy to discuss your situation further, but until that time, it is assumed no client/CPA relationship exists. Information within this blog has not been confirmed for accuracy and in many instances has been reposted from other sources.
References: Reg. Section 1.1031(k)-1(g)(6), PLR 200027028, First American Exchange