Possible relief for clients of bankrupt 1031 exchange companies

The IRS recently indicated that it is contemplating tax relief, in some form, for taxpayers have who have not able to complete their like-kind exchange because they used a qualified intermediary (QI) that went bankrupt. In many cases, clients of these bankrupt 1031 exchange companies have not only lost the principal held by the accommodator, they are now subject to capital gains tax and depreciation recapture because they failed to complete their exchange.

In a letter to Representative Barney Frank, a client of a bankrupt 1031 exchange provider requested that the issue of an extension of the period to complete a 1031 like-kind exchange be exteneded. The IRS responded to Rep. Frank that Code Sec. 1031 does not provide for an extension of the statutory replacement period. They also noted that the law only authorizes it to postpone deadlines for Presidentially-declared disasters or terrorist or military actions. However, the Qualified Intermediary that declared bankruptcy action is not subject to one of the events covered under a disaster. Thus, the IRS indicated it does not have the authority to suspend or extend a statutorily mandated due date.

The IRS also said that because of the number of QI businesses that have experienced financial difficulties resulting in bankruptcy filings, the are considering action to provide some type of relief. The nature of that relief was not specified.

The IRS has expressed a willingness to help homeowners that have been subject to foreclosure. While some form of relief for taxpayers for clients of bankrupt QIs is possible from the IRS, there is also the possibility that Representative Frank or other legislators may work to provide statutory relief. Unfortunately, this doesn't get the principal back. That is up to the bankruptcy proceedings - a slow and often times frustrating and disappointing process for these "creditors".

The issue of selecting a competent and secure Qualified Intermediary is highlighted by these recent failures of exchange providers. We focused on What to Look for in a Qualified Intermediary, a couple weeks back. I would encourage you to please review that article along with other references on our linked websites to the right for further guidance.