THEY MADE A FATAL MISTAKE...!
Taxpayers who want to sell investment, rental or business real estate and reinvest in like-kind property can readily transform what would be a taxable sale into a like-kind exchange. Regulation Section 1.1031 (k) -1 provides specific "safe harbor" procedures to properly complete an exchange. However, it is critical for taxpayers to follow the regulation to the letter. Otherwise, as a recent Tax Court case illustrates, the tax break will be lost.
IRS Regulation Section 1.1031 (k) - 1 (g) (3) (ii) states:
"a qualified escrow account is an escrow account wherein - (A) The escrow holder is not the taxpayer or a disqualified person, and (B) The escrow agreement expressly limits the taxpayer's rights to receive, pledge, borrow, or otherwise obtain benefits of the cash or cash equivalent held in the escrow account as provided in paragraph (g) (6) of this section."
In addition to insuring the escrow funds are held by a qualified person, the important provisions from above are that there must be a written agreement and it must contain the restrictions provided for in paragraph (g)( 6) of the regulation.
THE FACTS
In a 1996 Tax Court Decision - Michael Hillyer v. Commissioner, TC Memo 1996-214 - it was decided that a qualified escrow account did not exist and the transfer of the relinquished property was in fact a sale and not a tax deferred exchange. An S Corporation had entered into an agreement in January 1991 to dispose of a property and settlement occurred in August 1991. The net proceeds from closing were deposited with a Bank under an escrow agreement whereby the Corporation could designate replacement properties. The escrow agreement also contained a 180 day time limit but no other restrictions. The Corporation designated three properties in September 1991, two of which were eventually acquired. Both replacement properties were closed in January 1992 with the Bank providing the down payment from the escrow account.
THE FATAL FLAW
In examining the escrow agreement with the Bank, the court concluded that the (g)( 6) restrictions in the regulation, that are required for the qualified escrow agreement "safe harbor", were not present. Funds were actually received by the Corporation and then transferred to the Bank. The escrow agreement contained no restrictions upon the right of the Corporation to use the funds. The Court concluded that a sale of the relinquished property occurred in August 1991 for cash and that the Corporation must pay tax on its gain.
You Can Avoid Making A Fatal Mistake....
BE CERTAIN TO USE A PROFESSIONAL QUALIFIED INTERMEDIARY |
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