Part of the 1031 XChange Index - Originally Published 6/15/2007 at STEC

Once a QI enters into an exchange agreement with a taxpayer, there are certain fiduciary rules that pertain to taxpayer funds and property.

As a general rule in exchanges, the QI will disburse proceeds based on one of the following conditions:

• Taxpayer failed to identify any replacement property within the 45-day safe harbor window and the exchange has reached the 46th day.
• Taxpayer has received all replacement property to which he or she is entitled under the property identification form.
• Material and substantial contingency has occurred after the identification period has expired, said contingency being out of the control of the taxpayer, the occurrence relates to the exchange, and was provided for in writing.

The exchange agreement entered into between the QI and the taxpayer should list these situations as exceptions to the rule that the taxpayer does not have the right to receive, pledge, borrow, or benefit from the proceeds before the end of the exchange.

Practically speaking, these restrictions on disbursements apply to taxpayers in the following ways:

• Taxpayers may not expect any access to their proceeds within the first 45 days of the exchange except insofar as the QI may need to disburse some earnest money for a replacement property contract or the taxpayer may be ready to actually close on a replacement property.
• Taxpayers who have identified more than one replacement property may not ask the QI for a disbursement prior to the end of the exchange period or acquisition of all identified properties.
• Taxpayers cannot ask for an early disbursement because they changed their minds about buying a piece of property identified in a timely manner.
• Taxpayers may have access to their account if the identified property is destroyed by an Act of God (i.e., flood literally washing away the contracted-for property).
• Taxpayers may have access to their account if the seller of replacement property irrevocably breaches the contract after the identification period and there is insufficient time to cure the breach or sue for specific performance.
• Taxpayers may not have access to proceeds in order to pay a debt or purchase non-like-kind property.

This limited control over funds and/or property during the exchange is a key distinction between a straight sale and purchase and reaping the tax benefits of a like kind exchange.