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Under one of the safe harbors provided by the §1031 regulations, a taxpayer's transferee may be the taxpayer's agent provided that the transferee is a “qualified intermediary” and the taxpayer's rights to receive money or other property from the qualified intermediary are limited to the circumstances specified in Regs. §1.1031(k)-1(g)(6). A qualified intermediary is a person who is not the taxpayer or a “disqualified person” and enters into an agreement (“exchange agreement”) with the taxpayer and, as required by the exchange agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property, and transfers the replacement property to the taxpayer. Consistent with Rev. Rul. 90-34, 1991-1.
C.B. 154, the transfer of property through a deferred exchange that is facilitated by the use of a qualified intermediary may occur via a “direct deed” of legal title by the current owner of the property to the ultimate owner.
The qualified intermediary's acquisition and transfer of both the relinquished and replacement property must be “as required by the exchange agreement.” This phrase seems to imply that the required written exchange agreement between the qualified intermediary and the taxpayer, in addition to providing for the exchange of the relinquished and replacement property between the intermediary and the taxpayer, must also provide for the intermediary's transfer of the relinquished property and acquisition of the replacement property.
The recent bankruptcy filing under Chapter 11 by LandAmerica Financial Group, Inc., U.S. Bankruptcy Court Eastern District of Virginia (Richmond) (Bankruptcy Petition #:08-35994-KRH) (11/26/08) (“LandAmerica”), may have adverse tax consequences to taxpayers utilizing LandAmerica or others as a qualified intermediary in a §1031 deferred exchange. Assuming taxpayers can even get their money back from a bankrupt qualified intermediary within the requisite time period to consummate the like-kind exchange, the question arises whether the use of a substitute qualified intermediary because of the bankruptcy of the original qualified intermediary would still allow taxpayers to complete their §1031 deferred exchanges on a tax favorable basis.
Until recently there appeared to be no direct authority on the issue either in the statute, or regulations.
However, in PLR 200908005, the IRS appears to have granted some relief on substituted qualified intermediaries. In the ruling, holding company (“Taxpayer”) conducted investment banking services, small business and commercial banking, asset management and private equity through its subsidiaries. Bank was a wholly owned subsidiary of Taxpayer. Bank was also the sole member of a single member liability company (“LLC”). Bank, LLC and LLC's subsidiaries served as qualified intermediaries and exchange accommodation titleholders for like-kind exchanges.
Bank previously purchased the assets of an unrelated S corporation (“S Corp”). At the time of the sale, S Corp owned all of the stock of three subsidiaries (Q Sub 1, Q Sub 2 and Q Sub 3) who each acted as a qualified intermediary in large volume, like kind exchanges of automobiles and trucks.
Taxpayer wanted to take direct ownership of Q Sub 1, Q Sub 2 and Q Sub 3 by having S Corp transfer the stock of the three subsidiaries to LLC. The three subsidiaries would continue to act as qualified intermediaries as described above. Since LLC was not a qualified S Corporation shareholder, each of the Q Subs would convert to C corporation status and thus would not be disregarded entities for tax purposes. There would be no change in the way the Q Subs conducted business except that the Q Subs would be considered new entities for tax purposes.
The IRS ruled that, notwithstanding that the transfer of ownership of Q Sub 1, Q Sub 2 and Q Sub 3 would result in a new tax identity for each of the three corporations from disregarded entities to C corporations, the three entities would be the same for state law purposes. Therefore, the IRS concluded that the conversion of the three Q Subs would not be considered a change in the qualified intermediaries.
The ruling certainly is positive news for §1031 professionals. The converted C corporation was a different entity from the Q Subs for federal income tax purposes, but the IRS did not treat the new entities as different entities and thus a violation of the qualified intermediary rules. It remains to be seen if the acquisition of the obligations of a bankrupt or insolvent qualified intermediary by another entity will lead to the same result.
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