Safe Harbor for Failed Like-Kind Exchanges Where Qualified Intermediary Goes Bankrupt

The IRS has provided a safe harbor for taxpayers who start a like-kind exchange but fail to complete the exchange because the qualified intermediary (QI) goes bankrupt and defaults on its obligation to acquire replacement property (Revenue Procedure 2010-14).


Taxpayers often use QIs to help them complete a tax-free like-kind exchange under IRC § 1031. The QI will acquire the relinquished property from the taxpayer, transfer the relinquished property to a buyer, acquire replacement property, and transfer the replacement property to the taxpayer. For tax purposes, this is treated as a tax-free exchange between the taxpayer and the QI.


Occasionally, the QI will receive the relinquished property from the taxpayer but fail to acquire and transfer replacement property to the taxpayer, often because the QI has gone bankrupt. The IRS does not want to punish taxpayers who are unable to complete a like-kind exchange when the bankrupt QI defaults. Therefore, the revenue procedure provides a safe harbor, under which taxpayers in this situation will not be required to recognize gain on the failed exchange until they receive payment attributable to the relinquished property.


To be eligible for this safe harbor, the taxpayer must have initiated an exchange with a QI who defaults because the QI becomes subject to a bankruptcy proceeding under federal law or a receivership under federal or state law. The taxpayer must not have received proceeds from the disposition of the relinquished property prior to the time the QI entered bankruptcy or receivership.


The revenue procedure provides a gross profit ratio method for determining when taxpayers recognize any income from the transaction. Under this method, the portion of any payment attributable to the relinquished property that is recognized as gain is determined by multiplying the payment by a fraction, the numerator of which is the taxpayer’s gross profit and the denominator of which is the taxpayer’s contract price. For these purposes, the taxpayer’s gross profit means the selling price of the relinquished property minus the taxpayer’s adjusted basis.


The revenue procedure provides five examples of how the safe harbor works. The safe harbor applies to like-kind exchanges that fail due to a QI’s default occurring on or after Jan. 1, 2009.


The IRS has requested comments on whether additional guidance is needed on this topic. The comment deadline is April 12, 2010. Comments should be e-mailed to, with “Rev. Proc. 2010-14” in the subject line.



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