IRS Rules on Failed 1031 Exchanges Due to Collapse of the Qualified Intermediary

By
Services for Real Estate Pros with Exeter 1031 Exchange Services, LLC President & CEO

The Internal Revenue Service issued Revenue Procedure 2010-14 on March 5, 2010 that outlines a safe harbor procedure that provides guidance to investors on how to treat and report either a gain or loss due to a failed 1031 Tax Deferred Exchange transaction that resulted from the failure or collapse of their Qualified Intermediary. 

IRS Keenly Aware of Failed 1031 Exchange Problem

The IRS indicated that it is keenly aware of situations in which investors have entered into 1031 Exchange transactions by transferring relinquished property to a Qualified Intermediary and were unable to complete these 1031 Exchange transactions within the 1031 Exchange deadline due to the failure of the Qualified Intermediary to acquire and transfer replacement property to the investor. 

In many of these cases, the Qualified Intermediary has also entered bankruptcy or receivership, thus preventing the investor from obtaining immediate access to their 1031 Exchange funds from the sale of their relinquished property.

Investors Acting in Good Faith Should Not Be Taxed

The Internal Revenue Service generally holds the view that an investor who acted in good faith to complete their 1031 Tax Deferred Exchange using their Qualified Intermediary, but who failed to do so because their Qualified Intermediary defaulted under the terms of the 1031 Exchange Agreement and became subject to a bankruptcy or receivership proceeding, should not be required to recognize a gain or loss from the failed 1031 Exchange until the taxable year in which the investor receives a payment attributable to the relinquished property.

Revenue Procedure 2010-14 Provides Relief

Consequently, the Internal Revenue Service will not treat the investor as having actual or constructive receipt of their 1031 Exchange funds if the investor reports their gain or loss in accordance with Revenue Procedure 2010-14Rev. Proc. 2010-14 provides sorely needed tax relief to investors that have suffered through a failed 1031 Exchange due to a default by their Qualified Intermediary. 

Comments (4)

Cynthia Larsen
Cotati, CA
Independent Broker In Sonoma County, CA

That is good news indeed.  I did a 1031 exchange a couple of years ago and was nervous the whole time of the intermediary holding the money.  I couldn't fathom the thought of them declaring bankruptcy in the middle of the exchange!

Mar 09, 2010 05:01 AM
Bill Exeter
Exeter 1031 Exchange Services, LLC - San Diego, CA
1031 Tax-Deferred Exchange Expert

Hi Cynthia,

Yes, unless you have your Qualified Intermediary establish a separate Qualified Trust Account or Qualified Escrow Account separate from others.  This is not a separate bank account, but rather a separate Qualified Trust Account or Qualified Escrow Account.  This issue was addressed in the bankruptcy filing of LandAmercia 1031 Exchange.  Here is a link for more information: http://www.exeter1031.com/Selecting_SAFE_Qualified_Intermediary.aspx.

Mar 09, 2010 05:21 AM
Anonymous
Richard Wielde

Bill,

Thanks for posting the good news on the IRS position.

Mar 09, 2010 10:03 PM
#3
Bill Exeter
Exeter 1031 Exchange Services, LLC - San Diego, CA
1031 Tax-Deferred Exchange Expert

Hi Richard,

You are very welcome.  It is important information for those who have been affected by these 1031 Exchange Qualified Intermediary failures during these difficult times.

Mar 09, 2010 11:23 PM