Whose Money Is It Anyway? Part II

Last month the U.S. Bankruptcy Court for the Eastern Division of Virginia ruled, in Millard Refrigerated Services, Inc. v. LandAmerica 1031 Exchange Services, Inc., that funds held by a Qualified Intermediary ("QI") in connection with a tax-deferred exchange under IRC Section 1031 constituted property of the QI's bankruptcy estate.

In its opinion, the Court found that the relationship between LandAmerica Exchange Services, Inc. ("LES") and Millard Refrigerated Services, Inc. ("Millard") was that of debtor and creditor, and not, as Millard contended, one of trustee and beneficiary. Millard asserted the funds should be excluded from LES' bankruptcy estate because of the existence of an express trust or the imposition of a resulting trust between the parties.

However, the Court found that the parties' actions evidenced their intention to not create a trust arrangement. Citing the clear limitation of LES' duties to only those contained in the Exchange Agreements, the Court concluded that LES was under no fiduciary duty to deal with the property for the benefit of Millard nor did there exist any special relationship of trust or good faith that went beyond the duties of any ordinary contract between commercial parties.

What does this mean for Taxpayers entering into like-kind exchanges?

1. Taxpayers have options:

The Treasury Regulations permit the use of multiple safe harbors to secure the transferee's obligation to deliver replacement property which, in addition to the Qualified Intermediary safe harbor, include the use of a separate qualified trust. While the terms and conditions of the safe harbors must be satisfied separately, they are not mutually exclusive.

Millard and LES did not have a separate trust agreement and did not avail themselves of the safe harbor provisions for a qualified trust arrangement.

2. Taxpayers make choices:

The Court in Millard concluded that the parties' intention to not create a trust could be gleaned, in part, from the fact that they chose to utilize only the Qualified Intermediary safe harbor to the exclusion of the other safe harbors available to them under Treasury Reg. 1.1031(k)-1(g).

How is CDEC's structure different from the LES structure?

At CDEC, our first priority has always been the safety of our clients' funds.

For twenty years we've utilized both the Qualified Intermediary and Qualified Trust safe harbors.

In addition to signing an Exchange Agreement evidencing the Taxpayer's intent to effectuate a tax-deferred exchange, every one of our clients executes a separate Qualified Exchange Trust Agreement, with Bank of America acting as the third-party Trustee. The Taxpayer is the beneficiary of the trust.

Whether a trust is created is determined by state law. According to the written opinion of outside bankruptcy counsel, the trust assets, under Illinois law, do not constitute property of CDEC's bankruptcy estate or the Trustee's bankruptcy estate in the event either CDEC or the Trustee becomes a debtor under Chapter 11 of the U.S. Bankruptcy Code.

Don't Taxpayers have "constructive receipt" of their sale proceeds if they are the beneficiaries of a qualified trust account?

No. The Treasury Regulations 1.1031(k)-1(g) specifically allow a taxpayer to utilize the qualified trust safe harbor as a security device.