By: Diane Schaefer, CES^TM/ President - Exchange Solutions, Inc.

Full Title:

AT WHAT TIME IS IT APPROPRIATE FOR A QUALIFIED INTERMEDIARY TO FINANCE A TAXPAYER’S COSTS ON REPLACEMENT PROPERTY?

Frequently the Taxpayer will want the Qualified Intermediary to make a contract deposit or pay other payments on the Replacement Property with the exchange funds currently being held by the Intermediary from the sale of the Relinquished Property. Payments can successfully be made and qualify for the exchange as long as the (g)(6) limitations are not violated wherein a Taxpayer’s rights to receive, pledge, borrow or otherwise obtain the benefits of the cash held by the Qualified Intermediary are extremely limited.

Safe Harbor 3 supports the use of a fourth party and resolves the agency and constructive receipt issues. The qualified intermediary must abide by the requirements of this safe harbor in order not to be considered an agent of the Taxpayer. The safe harbor survives only if there is a written agreement between the Taxpayer and the Qualified Intermediary detailing the limits of the Taxpayer’s rights to the exchange proceeds and both parties adhere to the requirements (Reg. Section 1.1031(k)-1(g)(6)).

Once the Taxpayer and the Seller of the Replacement Property execute the contract of sale, an assignment of the incidence of ownership is conveyed by the Taxpayer to the Qualified Intermediary, as Purchaser. The Intermediary can now advance the contract deposit on the Replacement Property. This will prevent the Taxpayer from constructively receiving the funds and tainting the exchange.

If the Taxpayer funds the contract deposit directly to the Seller’s Attorney’s escrow account with ancillary funds, the Taxpayer cannot be reimbursed by the Qualified Intermediary until after the closing of the last Replacement Property. However, it is most seamless for the Seller’s Attorney to reimburse the Taxpayer directly, if the Qualified Intermediary has sufficient funds to acquire the replacement property.

Should there be additional costs such as legal fees, title insurance premiums, loan application fees, etc. that need to be paid with respect to the closing, the Intermediary can make payments for such expenses. However, it should be determined whether or not these items are transactional costs or actual purchase expenses. If the expenditure is not typically found on the closing statement, then the Taxpayer should pay this cost directly in lieu of the Intermediary utilizing the exchange proceeds.

A Taxpayer should always consult with a Tax Advisor while engaging in a tax-deferred exchange and inquire when payments made by the Qualified Intermediary will and will not taint the exchange.