The Statewide Title Newsletter and Legal Memorandum

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Issue  14  Article  27
Published:  9/1/1996

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"Safe Harbors"
Alex Pinkston and Ed Urban

Under IRC Section 1031, when a taxpayer is in actual or constructive receipt of money or other property before like-kind property is received, gain or loss may be recognized. However, there are four safe harbors which, if satisfied, result in a determination that the taxpayer is not in actual or constructive receipt of money or other property.

The four safe harbors are (1) Security or Guarantee Arrangements, (2) Qualified Escrow Accounts and Qualified Trusts, (3) Qualified Intermediaries, and (4) Interest and Growth Factors. I.R.S. Reqs. Section 1.1031(k)-1(g) deals with these "safe harbors."

Security or Guarantee Arrangements. The question of whether a taxpayer is in actual or constructive receipt of money or other property before the taxpayer actually receives like-kind replacement property is made without regard to the fact that the obligation of the taxpayer's transferee to transfer the replacement property to the taxpayer is or may be secured or guaranteed by one or more of the following:

(1) Mortgage, Deed of Trust, Other Security Interest in Property (other than cash or cash equivalent)

(2) Stand-by Letter of Credit which satisfies all requirements of Sec. 15A.453- 1(b)(3)(iii) and which may not be drawn upon in the absence of a default of the transferee's obligation to transfer like-kind replacement property to the taxpayer;

(3) The Guarantee of a Third Party.

However, when the taxpayer has an immediate ability or unrestricted right to receive the money or other property pursuant to the security or guarantee arrangement, this safe harbor no longer applies.

Qualified Escrow Accounts and Qualified Trusts. The determination of whether there has been actual or constructive receipt is made without regard to the fact that the obligation of the taxpayer's transferee to transfer the replacement property to the taxpayer is or may be secured by cash or a cash equivalent held in a qualified escrow account or in a qualified trust.

With a qualified escrow account, the escrow holder cannot be the taxpayer or a disqualified person, and the escrow agreement must expressly limit the taxpayer's rights to receive, pledge, borrow, or otherwise obtain the benefits of cash or cash equivalents held in the escrow account.

With a qualified trust, the trustee cannot be the taxpayer or a disqualified person, and the trust agreement must expressly limit the taxpayer's rights to receive, pledge, borrow, or otherwise obtain the benefits of cash or cash equivalents held by the trustee.

This safe harbor no longer applies when the taxpayer has an immediate ability or the unrestricted right to receive, pledge, borrow, or otherwise obtain the benefits of cash or cash equivalents held in the qualified escrow account or qualified trust account. However, the taxpayer may receive money or other property directly from a party to the exchange without affecting the safe harbor as long as it is not received from the qualified escrow account or the qualified trust.

Qualified Intermediaries. When the taxpayer's transfer of relinquished property involves a qualified intermediary, the qualified intermediary is not considered the taxpayer's agent for purposes of Sec. 1031(a). However, this safe harbor applies only if the agreement between the taxpayer and the qualified intermediary expressly limits the taxpayer's right to receive, pledge, borrow or otherwise obtain the benefit of the money or other property held by the qualified intermediary.

The taxpayer can receive money or other property directly from a party to the transaction other than the qualified intermediary without affecting this safe harbor.

The regulations define a qualified intermediary as a person who

(1) is not the taxpayer or a disqualified person;

(2) enters into a written agreement with the taxpayer ("the exchange agreement") and, as required by the exchange agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property, and transfers the replacement property to the taxpayer.

Interest and Growth Factors. The fact that the taxpayer is or may be entitled to receive any interest or growth factor does not affect whether the taxpayer is in actual or constructive receipt of money or other property before he actually receives the like-kind replacement property. The taxpayer is treated as entitled to receive interest or a growth factor with respect to a deferred exchange if the amount of the money or property the taxpayer is entitled to receive depends upon the length of the time elapsed between the transfer of the relinquished property and the receipt of the replacement property. If interest or a growth factor is received, it will be treated as interest regardless whether it is paid to the taxpayer in cash or property (including property of like-kind). However, the taxpayer must include the interest or growth factor in his income according to the taxpayer's method of accounting. Also, see I.R.S. Reqs., Section 1.1031(k)-1(h) pertaining to interest and growth factors.

Statewide Title, Inc.'s subsidiary Statewide Title Exchange Corporation acts as a qualified intermediary. Please call us for a set of excellent forms available in hard copy or on diskette.


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