The G6 Limitations: Reg. (g)(6) Rules on Exchange Funds

The term comes from one paragraph of the deferred exchange regulations, and three safe harbors depend on it.

Reg. section 1.1031(k)-1(g)(6) says an agreement limits your rights only if it provides that you have no rights to receive, pledge, borrow or otherwise obtain the benefits of money or other property before the end of the exchange period, except as paragraphs (g)(6)(ii) and (iii) allow. The qualified escrow account and qualified trust in (g)(3), the qualified intermediary in (g)(4) and the interest safe harbor in (g)(5) all require that wording.

The exchange period ends at midnight on the earlier of the 180th day after the transfer of the relinquished property or the due date, with extensions, of your return for that year, under Reg. section 1.1031(k)-1(b)(2). That date is the outer wall for the funds.

Paragraph (g)(6)(ii) allows release at any time after the identification period if you identified nothing. Paragraph (g)(6)(iii) allows release, if you did identify, upon or after receipt of all the replacement property you are entitled to under the exchange agreement, or after a material and substantial contingency that occurs after day 45, relates to the exchange, is provided for in writing and is beyond your control and the control of any disqualified person.

In a hypothetical exchange, the release date depends on which door you walk through.

Hypothetically, you close a sale on 1 March and $600,000 goes to the intermediary. If you identify nothing by day 45, the agreement can let you take the money after that day. If you identify two properties and close on both by day 120, the balance can come back once the second deed records.

If you identify two properties, close on one and the other buyer simply walks away, the money left over generally waits for the end of the exchange period unless the agreement defines your entitlement or a qualifying written contingency differently. Example 2 in Reg. section 1.1031(k)-1(g)(8) shows a rezoning contingency doing exactly that. Run your own dates with your CPA.

It bites when you try to reach the money early, and the agreement cannot be rewritten mid-exchange.

Reg. section 1.1031(k)-1(g)(4)(vi) ends the safe harbor the moment you have an immediate ability or unrestricted right to the funds. Example 2 in (g)(8) shows the consequence: a right to draw the full escrow on a date before the replacement arrived meant constructive receipt of the whole amount, and the transaction became a sale even though the taxpayer never asked for the money.

Two carve-outs soften the rule. Under (g)(7), closing-statement items such as commissions, prorated taxes, recording fees and title charges, and incidental personal property worth no more than 15 percent of the replacement real property, are disregarded in testing the restrictions. Other payments out of the account are tested against the restrictions; see whether you can touch or borrow exchange funds.

For what happens to the money once the exchange fails, see when a QI must release funds in a failed exchange and the exchange agreement that carries these terms.