IRS unveils safe harbor for certain failed like-kind exchanges

The IRS has unveiled a much-anticipated safe harbor for participants in multiple-party like-kind exchanges under Code Sec. 1031 that have gone bad because of the default of qualified intermediaries (QIs) during the current economic downturn. The safe harbor for reporting gain or loss is available to taxpayers that initiated deferred like-kind exchanges but failed to complete the exchange due to a QI's default on its obligation to timely acquire and transfer replacement property when its assets are suddenly frozen in bankruptcy or receiverships.

If a taxpayer satisfies the safe harbor requirements, the taxpayer will not be deemed to be in actual or constructive receipt of any of the exchange proceeds until the QI emerges from bankruptcy or receivership and, then, will recognize gain only as required under the safe harbor gross profit ratio method.

When a QI default occurs because of bankruptcy or receivership, a taxpayer should not be required to recognize gain from the failed exchange until the tax year in which the taxpayer receives a payment attributable to the relinquished property, according to the IRS.

Safe harbor

The safe harbor, in Revenue Procedure 2010-14, applies to taxpayers that:

-- Transferred relinquished property to a QI (in accordance with regulations);

-- Properly identified replacement property within the identification period (unless the QI default occurs during that period);

-- Did not complete the like-kind exchange solely because of a QI default involving a bankruptcy or a receivership; and

-- Did not, without regard to any actual or constructive receipt by the QI, have actual or constructive receipt of the proceeds from the disposition of the relinquished property or any property of the QI prior to the time the QI entered bankruptcy or receivership.

The safe harbor in Rev. Proc. 2010-14 is effective for taxpayers whose like-kind exchanges failed due to a QI default on or after January 1, 2009.

For more information or to discuss your qualifications to use the safe harbor, please call our office.