Constructive Receipt

In order for your real estate exchange to qualify under IRC 1031, you must never be in "constructive receipt" of any money or other property for the relinquished property, before you receive the replacement property. That is why the IRS requires that you go through a qualified intermediary when doing a 1031 exchange. The QI acts as a "safe harbor" so that you never receive any money from your sale, and in turn, can delay paying your capital gains taxes.

What Is Constructive Receipt?

Constructive receipt refers to you, the investor, having control of the equity from the property you sold. If you gain control of these funds, your 1031 exchange is voided and you cannot defer your taxes. Therefore, you must receive the replacement property before you receive control of any profit from your relinquished property.

Often, timing in real estate sales is not perfect. Allowing a QI to handle your transactions will help you avoid constructive receipt. You want to avoid this or else your profit will be taxed at the regular rate for capital gains. Why go through the trouble of doing a 1031 exchange if you are going to pay taxes upfront?

To ensure that you are never in constructive receipt of any payments, you must follow the "safe harbor" rules that the IRS has set. These provide you with security against loss in case the other parties fail to go through with the exchange. They include security arrangements, qualified trusts and escrow accounts, qualified intermediaries, and interest/growth factors. Incidentally, you can earn interest during the escrow period without it being considered constructive receipt.