Why Constructive Receipt Can Quash Your 1031 Exchange
A 1031 Exchange allows you to defer capital gains taxes when selling investment or commercial property, but only if you follow all IRC Section 1031 rules and regulations to the tee. One of the fastest ways to lose your deferral is falling into the constructive receipt trap.
What is Constructive Receipt in a 1031 Exchange?
Definition of Constructive Receipt
One of the fundamental rules of Section 1031 is that an exchanger is not permitted to have any control of the proceeds from the sale of their property until those funds are used for the purchase of new property. Most Exchangers understand that they can’t “actually” receive the exchange funds or the economic benefit of the exchange funds, but not everyone understands the idea of constructive receipt.
Constructive receipt occurs when the exchanger has the ability to control the sale proceeds such as when the funds are in the possession of an agent of or a related party to the exchanger. Having actual or constructive receipt of the exchange funds results in a taxable sale rather than tax deferral through a valid 1031 Exchange.
Key Constructive Receipt Takeaways
- Actual receipt = direct physical control over the exchange funds = taxable event
- Constructive receipt = indirect control over funds = taxable event
- Safe harbor = Qualified Intermediary with proper documentation
- Risk = Inadvertently having actual or constructive receipt of the exchange funds
- Solution = trust IPX1031 to protect your 1031 Exchange
Case Study: Crandall v. Commissioner
In the Crandall v. Commissioner case, the taxpayer sold Arizona investment land with the clear intent to perform a 1031 Exchange into a Replacement Property in California.
However, the taxpayer made one critical mistake: they did not engage a Qualified Intermediary (QI). Instead, the taxpayer relied on their title/escrow company to “hold” the funds. The IRS ruled that the taxpayer had constructive receipt of the proceeds making the exchange ineligible for 1031 deferral. The tax bill was immediate and significant.
From a practical standpoint, the funds may have seemed secure, but from the IRS’s perspective, it failed to meet the strict safe harbor requirements under Treasury Regulations §1.1031(k)-1. Without a compliant exchange agreement in place, the taxpayer retained constructive control over the funds.
Lesson: Intent alone isn’t enough. Structure and documentation are critical.
The Safe Harbor Solution: Qualified Intermediaries
IRS rules provide “safe harbors” to prevent actual or constructive receipt of exchange funds. The most popular safe harbor is the use of a 1031 Qualified Intermediary, like IPX1031. The critical role of a Qualified Intermediary is to receive and hold exchange funds under a written agreement that eliminates your access or control of funds until you purchase your new property.
What Does a Qualified Intermediary Do?
- Structures and documents the exchange transaction to follow IRS regulations
- Holds your funds in compliance with IRS regulations and eliminates actual or constructive receipt risk
- Prevents you from accessing or controlling your funds during the exchange period
Your Risk is Real—Your Solution is IPX1031
At IPX1031, we hold your exchange funds to safeguard your deferral. Our mission is to protect your monies with the highest level of security. As a Fortune 500® Fidelity National Financial company, IPX1031 delivers unmatched financial strength, precision, and peace of mind for every exchange. Additionally, our expertise ensures your transaction meets IRS requirements from day one.
Examples of Actual or Constructive Receipt
Taxable (Disqualifies Your 1031 Exchange)
- Funds wired directly to your account – considered actual receipt by the IRS.
- Funds held by your title or closing company but available to you – even without touching them, the ability to access means constructive receipt.
- Ability to direct or reassign funds at will – such as telling escrow to release them for personal use.
- Loan or advance made to you from the proceeds – borrowing against exchange funds is treated as receipt.
- Funds released before the Replacement Property is acquired – early access = taxable event.
Safe (Compliant with IRS Regulations)
- Funds held by a Qualified Intermediary (QI) under a written exchange agreement that removes your control.
- Funds in a properly restricted escrow account with terms that meet IRS safe harbor rules.
- Funds transferred directly from the QI to the seller of your Replacement Property without passing through your hands.
- Funds in a qualified trust or qualified escrow account where you have no access until the exchange is complete.
Additional Constructive Receipt Resources
Limitations on the Safe Harbors: The “(g)(6)” Restrictions
The Role of the Qualified Intermediary
How Important is Your Qualified Intermediary?
QI Importance to 1031 Exchange Success
Taxpayers are always advised to consult with their tax and legal advisors regarding the exchange status of a property.
We, at IPX1031, pride ourselves on not only being an industry leader in expertise, service and security, but we also strive to help our clients and their advisors keep current on tax issues pertaining to §1031 Exchanges and applications for them. We aim to be your complete information resource. For more information about us, visit our website at www.ipx1031.com, browse our complimentary webinars, or to initiate an exchange, fill out our online start a 1031 Exchange form to get started
