7844 / What safe harbor rules exist to help taxpayers engage in deferred like-kind exchanges of real estate?

(2) Qualified escrow accounts and qualified trusts: the transferee’s obligation to transfer the replacement property may be secured by cash or a cash equivalent if the cash or cash equivalent is held in a qualified escrow account or in a qualified trust. Generally, a qualified escrow account or qualified trust is an account (or trust) in which (a) the escrow holder (or trustee) is not the taxpayer or a disqualified person (defined below); and (b) the escrow (or trust) agreement expressly limits the taxpayer’s rights to receive, pledge, borrow, or otherwise obtain the benefits of the cash or cash equivalent held in the escrow account (or by the trustee).² The regulations specify how the escrow agreement or trust is to impose such limitations.³

(3) Qualified intermediary: A qualified intermediary is a person who is not the taxpayer or a disqualified person (defined below), and who enters into a written agreement (the “exchange agreement”) with the taxpayer and, as required by the exchange agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property, and transfers it to the taxpayer.⁴ So long as the agreement between the taxpayer and the qualified intermediary expressly limits the taxpayer’s rights to receive, pledge, borrow, or otherwise obtain the money or other property held by the qualified intermediary, the qualified intermediary will not be considered the agent of the taxpayer.⁵ The regulations specify how the agreement is to impose such limitations.⁶

The use of a qualified intermediary in an exchange involving two related parties caused the exchange to fail to qualify as a like-kind exchange when, as part of the transaction, one of the related parties received property not of like kind to the replacement property.⁷

(4) Interest and growth factors: The fact that the taxpayer is or may be entitled to receive any interest or growth factor with respect to the deferred exchange will not cause constructive receipt of money or other property, so long as the agreement expressly limits the taxpayer’s rights to receive the interest or growth factor.⁸ The regulations specify how the agreement is to impose such limitations.⁹ Generally, a taxpayer will be treated as being entitled to receive interest or a growth factor with respect to a deferred exchange if the amount of money or property the taxpayer is entitled to receive depends upon the length of time between transfer of the relinquished property and receipt of the replacement property.¹⁰

For purposes of the regulations, “disqualified person” generally means one of the following:

(a)  An agent of the taxpayer, including any person who acted as the taxpayer’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the two years preceding the transfer of the first of the relinquished properties. (However, the performance of services with respect to the like-kind exchange, or routine financial, title insurance, escrow, or trust services furnished by a financial institution, title insurance company, or escrow company is not taken into account for purposes of this paragraph.)¹¹

(b)  A “related person” as defined in Q 710, but using “10 percent” in each place that “50 percent” appears.¹²

(c)  Certain persons who are “related” (based on the definition in paragraph (b)) to a person who would be disqualified as described in paragraph (a). Certain banks and bank affiliates are exempt from this rule.¹³

The safe harbors and other provisions under Treasury Regulation Section 1.1031(k)-1 are effective for transfers of property made by taxpayers on or after June 10, 1991.¹⁴

Coordination with IRC Section 453

Additional safe harbors provide that, for purposes of the installment sales rules (see Q 667), transactions involving qualified escrow accounts, qualified trusts, and qualified intermediaries generally will not result in the receipt of payments to the transferor of relinquished property. Thus, in the case of qualified escrow accounts and qualified trusts, the determination of whether or not the taxpayer has received a payment for purposes of IRC Section 453 will be made without regard to the fact that the transferee’s obligation to transfer property is secured by cash or a cash equivalent held in a qualified escrow account or qualified trust. Also, in the case of qualified intermediaries, the determination of whether or not the taxpayer has received a payment for purposes of IRC Section 453 will be made as if the qualified intermediary is not the agent of the taxpayer. Both of these safe harbors apply only so long as the taxpayer has a bona fide intent to enter into a deferred exchange at the beginning of the exchange period and the relinquished property is held for productive use in a trade or business. These safe harbors apply to exchanges occurring after April 19, 1994.