Can You Ever Release Funds Early in a 1031 Exchange?

As an investor pursuing a #1031 exchange, your goal is to defer capital gains on the transactions. Of course, investors are only human, and life sometimes throws a curve ball that nobody anticipated. In some instances, like the illness of the investor or a substantial change of circumstances, the investor may seek an early release of exchange funds. Is this possible?

With very limited exceptions, the IRS says no. Not a very helpful bunch sometimes, it seems.

However, in certain circumstances, the IRS does permit for the early release of funds. The regulations permit limited exceptions here:

(A) The receipt by the taxpayer of all of the replacement property to which the taxpayer is entitled under the taxpayer agreement, or

(B) The occurrence after the end of the identification period of a material and substantial contingency that:

(1) Relates to the deferred exchange,

(2) Is provided for in writing, and

(3) Is beyond the control of the taxpayer and of any disqualified person (as defined in paragraph (k) of this section, other than the person obligated to transfer the replacement property to the taxpayer.

Of course, there was still ambiguity, so the IRS provided further clarification in Private Letter Ruling PLR200027028. This was issued in response to the general assumption that termination of the exchange on demand was possible, so long as the taxpayer was willing to pay full capital gains taxes due. However, the IRS says that absent an event under section (A) or (B), the exchange agreement cannot be amended to permit early distribution.

While cancelling an exchange may not matter to the investor, it is the Qualified Intermediary (who has a duty to adhere to a certain standard of conduct) who may face repurcussions. The bottom line is that the early return of funds is only permitted in very limited circumstances. Investors should plan accordingly.

If you’re considering a 1031 exchange, please visit our website to learn more about the exchange process, our qualified intermediary services and how we can help you find and close on your next 1031 exchange property.