Receipt, Agency, and Control

Paragraph (f) of the deferred exchange regulation states the rules that apply when a harbor is unavailable, and it is short, blunt, and largely unread. It repays close attention for two reasons. It supplies the analysis for every transaction that falls outside a harbor. And it explains why the harbors are drafted as they are, because each restriction in paragraph (g)(6) is a direct answer to a sentence in paragraph (f).

29.1 Actual receipt

The starting proposition is categorical. A transfer of relinquished property in a deferred exchange is not within the provisions of section 1031(a) if, as part of the consideration, the taxpayer receives money or other property.¹

That sentence would be devastating if it stood alone, and it does not. Such a transfer, if otherwise qualified, will be within the provisions of section 1031(b) or (c).² The taxpayer who receives cash alongside like-kind property has an exchange with boot rather than no exchange, and Chapter 33 quantifies the result.

The gradation that follows is the structural point of the paragraph and it is easy to miss on a first reading. Gain or loss may be recognized if the taxpayer actually or constructively receives money or other property before the taxpayer actually receives like-kind replacement property. But if the taxpayer actually or constructively receives money or other property in the full amount of the consideration for the relinquished property before actually receiving the replacement property, the transaction will constitute a sale and not a deferred exchange, even though the taxpayer may ultimately receive like-kind replacement property.³

Partial receipt produces boot. Receipt of the full consideration produces a sale, and the sale is not rescued by the taxpayer's subsequent acquisition of replacement property. This is the same proposition encountered at 24.1, stated from the receipt side rather than the exchange side.

The definition of actual receipt is broader than possession. The taxpayer is in actual receipt of money or property at the time the taxpayer actually receives the money or property, or receives the economic benefit of the money or property.⁴

The second branch does the work. A taxpayer who never touches the funds but has them applied to discharge a personal debt, directed to a creditor, or otherwise used for the taxpayer's benefit has received them. Payment to a third party at the taxpayer's direction is payment to the taxpayer.

One further sentence forecloses an argument that would otherwise be made in every case. Except as provided in the safe harbors, the receipt determination is made under the general rules concerning actual and constructive receipt and without regard to the taxpayer's method of accounting.⁵ An accrual method taxpayer, for whom constructive receipt is ordinarily irrelevant, gets no shelter here.

29.2 Constructive receipt in the exchange setting

The regulation adopts the general standard and states it in terms worth memorizing, because each clause corresponds to a structure someone has tried.

The taxpayer is in constructive receipt of money or property at the time the money or property is credited to the taxpayer's account, set apart for the taxpayer, or otherwise made available so that the taxpayer may draw upon it at any time, or so that the taxpayer can draw upon it if notice of intention to draw is given.⁶

Three triggers, and the third has two branches. Crediting to an account. Setting apart. Making available. And availability includes availability conditioned only on the taxpayer's giving notice of an intention to draw. A right that must be exercised is still a right, and a notice requirement is not a restriction.

The escape and its limit are stated in one sentence. The taxpayer is not in constructive receipt if the taxpayer's control of its receipt is subject to substantial limitations or restrictions, but the taxpayer is in constructive receipt at the time the limitations or restrictions lapse, expire, or are waived.⁷

Two things follow. A limitation must be substantial, and a limitation the taxpayer can remove at will is not. And receipt occurs on lapse, which means a restriction expiring on day one hundred seventy-nine produces receipt on day one hundred seventy-nine whether or not the taxpayer draws.

The regulation's example is the most instructive passage in paragraph (f), and its facts should be read carefully because the taxpayer did everything right.

A taxpayer transferred relinquished property worth $100,000 under an agreement providing for a deferred exchange. At any time after the transfer and before the replacement property was purchased, the taxpayer had the right, upon notice, to demand that the other party pay $100,000 in lieu of acquiring and transferring replacement property. The taxpayer did not demand payment. The taxpayer identified replacement property, the other party purchased it, and it was transferred to the taxpayer.⁸

The exchange failed. Because the taxpayer had the unrestricted right to demand payment as of the transfer date, the taxpayer was in constructive receipt of $100,000 on that date. Because that was the full amount of the consideration, the transaction constituted a sale, and the taxpayer was treated as having received $100,000 for the relinquished property and then purchased the replacement property.⁹

Nothing the taxpayer did mattered. The right existed, and the existence of the right was receipt.

The regulation then supplies the cure. Had the taxpayer's right to demand payment been subject to a substantial limitation or restriction, and the regulation's own illustration is an agreement providing that the taxpayer had no right to demand payment until the exchange period had run, the taxpayer would not have been in actual or constructive receipt unless and until the limitation lapsed, expired, or was waived.¹⁰

That illustration is paragraph (g)(6) in embryo. The reason a safe harbor agreement must state that the taxpayer has no rights to receive, pledge, borrow, or otherwise obtain the benefits of the funds before the end of the exchange period is that anything less leaves the taxpayer holding a right, and holding the right is receiving the money.

The counsel that follows is about documents rather than conduct. In examining a structure, the question is never what the taxpayer did with the funds. It is what the taxpayer was entitled to do.

29.3 Agency principles applied to intermediaries

One sentence at the end of paragraph (f)(2) supplies the reason the qualified intermediary safe harbor had to be invented. Actual or constructive receipt of money or property by an agent of the taxpayer is actual or constructive receipt by the taxpayer.¹¹

Standing alone that would end every deferred exchange. A person retained by the taxpayer to hold the proceeds, apply them at the taxpayer's direction, and acquire property for the taxpayer looks like an agent under any ordinary description, and money in an agent's hands is money in the principal's.

The parenthetical in that sentence is easy to skip and is doctrinally important. Agency for this purpose is determined without regard to paragraph (k).¹² The disqualified person definition examined in Chapter 28 does not define agency here. It performs an entirely different function, which is to police who may occupy a safe harbor role.

Two consequences follow, and they run in opposite directions.

A person who is not a disqualified person may nonetheless be the taxpayer's agent in fact. Passing the Chapter 28 screen establishes eligibility to serve, not the absence of agency.

A person who is a disqualified person is not thereby an agent for purposes of this attribution rule. The categories overlap without coinciding.

The qualified intermediary harbor answers the attribution rule by direction rather than by argument. Where the harbor applies, the intermediary is not considered the agent of the taxpayer for purposes of section 1031(a), and the receipt determination is made as if the intermediary is not the taxpayer's agent.¹³ The regulation does not contend that an intermediary is not an agent. It instructs that the question be answered as though it were not, and its example reaches that result expressly regardless of whether the intermediary was the taxpayer's agent under State law.¹⁴

The architecture is therefore a rule and an exemption. Paragraph (f)(2) attributes an agent's receipt to the taxpayer. Paragraph (g)(4)(i) removes the qualified intermediary from that attribution. A structure that fails the harbor does not merely lose a convenience; the attribution rule returns in full, and it is fatal.

Two practical points belong here because they are where the attribution rule actually bites in ordinary transactions.

The taxpayer's other professionals are not exempt. Where relinquished property proceeds are wired to the taxpayer's closing attorney, the taxpayer's property manager, or an escrow the taxpayer controls, rather than to the intermediary, the funds have been received by a person who is very likely the taxpayer's agent, and no harbor covers them. Wiring instructions carry more weight than their clerical appearance suggests, and they should be confirmed before the closing rather than corrected after it.

The intermediary must actually receive the funds. A structure in which the intermediary is documented but the money moves elsewhere has the paperwork of an exchange and the substance of a sale.

29.4 Pledges and the (g)(6) restrictions

The express limitation required by paragraph (g)(6) uses four verbs, and the choice is deliberate. The agreement must provide that the taxpayer has no rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property before the end of the exchange period.¹⁵

Receipt is only the first of the four. A taxpayer who never touches the funds, never directs their payment, and never has them credited to an account may still breach the limitation by pledging them or by borrowing against them, and the catch-all reaches arrangements that accomplish the same thing by another route.

The transactions this forecloses are the ones clients most want, and each should be recognized on sight.

Borrowing against the exchange funds. A taxpayer who needs cash for a deposit on replacement property, or for an unrelated purpose, asks the intermediary or a lender to advance funds secured by the balance held. That is borrowing against the funds and obtaining their benefits.

A loan from the intermediary. The same transaction dressed as a loan from the person holding the money is the clearest case. The intermediary is not permitted to advance exchange proceeds to the taxpayer.

Collateral for a bridge loan. Using the held funds as security for financing on the replacement property is a pledge, whether or not any amount is drawn and whether or not the lender is related to anyone.

Early release for a good reason. The taxpayer whose deal has collapsed and who needs the money is precisely the taxpayer the limitation binds, and 27.6 states the only two exits.

The permitted paths are narrow and should be used rather than improvised. A taxpayer may receive money or other property directly from a party to the exchange without affecting the escrow or trust harbor, but not from the qualified escrow account or the qualified trust.¹⁶ The source of the payment controls, so an adjustment funded by the buyer at the table is permissible where the identical amount released from escrow is not.

Ordinary closing mechanics are separately protected. The items disregarded under paragraph (g)(7) include transactional items that relate to the disposition of the relinquished property or the acquisition of the replacement property and that appear under local standards in the typical closing statements as the responsibility of a buyer or seller, and the regulation names commissions, prorated taxes, recording or transfer taxes, and title company fees.¹⁷

A recurring question sits just outside that list, and it deserves a candid answer rather than a confident one. Where the taxpayer has paid an earnest money deposit on replacement property from personal funds, may the intermediary reimburse the taxpayer from exchange proceeds at the replacement closing. The listed examples are all charges appearing on a settlement statement as a party's responsibility, and a deposit previously paid by the taxpayer is not naturally described that way. Practice varies, and the position is not free from doubt. The conservative course, and the one that eliminates the question, is to have the intermediary fund the deposit directly, which requires only that the intermediary be engaged before the deposit is made.

Finally, note what triggers the loss of a harbor. Each provision keys to the taxpayer's having an immediate ability or unrestricted right to obtain the funds, not to the taxpayer's exercising it.¹⁸ The analysis matches the example at 29.2. What the taxpayer may do is what matters.

Two boundaries close the chapter, because both are frequently confused with the restrictions above.

Pledging the replacement property after acquiring it is unrestricted. The limitation concerns the money held during the exchange, not the taxpayer's dealings with property the taxpayer owns.

Debt on either side of the transaction raises different questions entirely, governed by the boot rules rather than by receipt. Refinancing before and after an exchange is examined at 34.4.