Taxing Lessons Case Summaries

Case — Like-kind Exchange

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TL Case Summ


Does a property disposition qualify for deferred tax treatment if the escrow account holding the proceeds is not restricted?


Taxpayer Says: The funds placed in the escrow account were held solely for the purchase of the new property. The transaction qualifies as a like-kind exchange and the tax should be deferred.

Internal Revenue Service Says: The escrow agreement did not expressly restrict the taxpayers’ access to, and use of, the funds. The taxpayers were in constructive receipt of the proceeds and the gain must be recognized in the current year.


From Internal Revenue Code Section 1001(c): The general rule regarding recognition of gain or loss on the sale or exchange of property is that the entire amount of the gain or loss is recognized.

From Internal Revenue Code Section 1031: An exception to the general rule of gain recognition. States no gain or loss is recognized when business or investment property is exchanged solely for other business or investment property of like kind.

From Federal Tax Regulation 1.1031(k)-1(a): Gain or loss may be recognized if the taxpayer actually or constructively receives money that does not meet the qualifications of section 1031(a) before the taxpayer actually receives like-kind property.

From Federal Tax Regulation 1.1031(k)-1(f)(2): “The taxpayer is in constructive receipt of money or property at the time the money or property is credited to the taxpayer’s account, set apart for the taxpayer, or otherwise made available so that the taxpayer may draw upon it at any time.” If the taxpayer’s control of receipt of the money or property is subject to substantial limitations or restrictions, there is no constructive receipt.

From Klein v. Commissioner, T.C. Memo. 1993-491: The taxpayer’s own limitation of use of the funds does not convert the escrow account into a qualified escrow account.


In general, you have to pay tax on the gain from the sale of property in the year you sell it. However, when you exchange business or investment properties that are the same type, you can defer the gain by following the “like-kind” exchange rules of Internal Revenue code section 1031.

Among other requirements, to qualify for like-kind exchange deferral you must place the money you receive in a “qualified” escrow account until the transaction is complete. An escrow account is qualified when you are not the holder of the account and the escrow agreement limits your right to control or receive the money in the account.

In this case, the taxpayers sold property and placed the money in escrow accounts at two title companies. Because they received none of the proceeds and used the money only to purchase another property, they believed the escrow accounts were qualified, and the transaction was eligible for tax deferral as a like-kind exchange.

The Internal Revenue Service argued the escrow agreements did not reference a like-kind exchange under section 1031, nor did they expressly limit the taxpayers’ right to receive, pledge, borrow, or otherwise obtain the benefits of the funds. Because the escrow accounts were not qualified per section 1031 rules, the taxpayers constructively received the proceeds and the gain should be recognized in the year of sale.


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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit and

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.


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For the IRS. Although the taxpayers used the funds in the escrow account to purchase the replacement property, the lack of express limitations in the escrow agreements results in constructive receipt of the proceeds. The disposition was a sale and the transaction does not qualify for section 1031 nonrecognition. The taxpayers must recognize gain.