The qualified intermediary plays an important role because the seller cannot take possession of the sale proceeds.To do so blows the tax-deferred nature of the exchange.In addition, Land America had invested the customers’ funds in auction-rate securities which are very difficult to value and may be substantially impaired given the current credit climate (that’s also an investment strategy that got Land America in trouble – they ended up with worthless debt).
Here’s how IRS says a taxpayer qualifies for the safe harbor relief – the taxpayer must have transferred property in accordance with the like-kind exchange regulations; must have timely identified the replacement property; must not have completed the exchange because the qualified intermediary wound up in bankruptcy or receivership; and must not have had actual or constructive receipt of the proceeds from the disposition of the relinquished property before the qualified intermediary filed bankruptcy or went into receivership (but, being relieved of a liability under the exchange agreement before the qualified intermediary failed is ignored).
If a taxpayer meets those four tests, the taxpayer doesn’t have any gain or loss to report until the tax year in which payment (from the qualified intermediary, the qualified intermediary’s bankruptcy or receivership estate, or the qualified intermediary’s insurer or bonding company or any other person) is received. lays out further details concerning the definition of “contract price” and “gross profit” and “satisfied indebtedness.” As for imputed interest, IRS says that the property is deemed to be sold when the bankruptcy plan is confirmed (or upon any other court order resolving the taxpayer’s claims against the qualified intermediary).
Indeed, as mentioned above, existing Treasury Regulations provide safe harbors for parking funds with or without using a qualified intermediary.
That’s the tough lesson of the case – the problem was completely avoidable with proper planning.
Thus, it’s critical that the qualified intermediary take title to the seller’s property, sell it within the statutorily-prescribed time-frame and then acquire the replacement property (also within a certain time-frame) and transfer the replacement property to the seller.