When it comes to completing a successful 1031 exchange, few mistakes are as costly, or as common, as accidentally triggering constructive receipt. Investors sometimes call this “taking boot,” but whatever the label, the result is the same: your tax deferral may be jeopardized.
What Is Constructive Receipt?
Constructive receipt occurs when the IRS determines you had actual or potential control over your exchange proceeds. You do not have to physically cash a check or deposit money into your account for it to count. Even brief or indirect access to funds can trigger constructive receipt in the eyes of the IRS. And, if the funds are available to you in any way, even for a short time, the exchange is likely “off the table.”
For example:
If your sales proceeds are wired to your personal account, even for a day, you have taken actual receipt.
If the check from closing is made payable to you, you have taken constructive receipt.
If you instruct the closing agent to hold the funds “until you decide what to do,” that too can be seen as constructive receipt.
Having the funds held by your agent, your employee, or a relative can be construed as constructive receipt.
How “Boot” Fits into the Picture
The term “boot” refers to any cash or non-like-kind property you receive during a 1031 exchange. Boot is taxable in the year of the exchange, even if the rest of the transaction qualifies for deferral.
This means:
Taking all proceeds in boot = no valid exchange.
Taking some proceeds in boot = partial exchange. You may defer tax on the reinvested portion but owe tax on the boot.
It is easy to see why constructive receipt and boot get conflated. In both situations, the investor winds up with taxable money in hand.
How to Avoid Constructive Receipt
The good news? Avoiding constructive receipt is straightforward if you plan ahead. The IRS requires that exchange funds be placed in the hands of a Qualified Intermediary (QI), not the taxpayer.
Here is what that looks like in practice:
At closing, your sales proceeds are wired directly to your QI, never to you.
The QI safeguards the funds during your identification and exchange period (preferably through a separate, segregated bank escrow account.)
When you close on your replacement property, the QI wires the funds directly into that purchase.
By keeping your funds out of reach, the QI eliminates constructive receipt and ensures your exchange complies with IRS safe-harbor rules.
Why This Matters
Receiving funds can be an innocent mistake. For example, a poorly worded instruction at closing, or a misunderstanding of the rules could result in receipt. But the consequences are serious. Once receipt occurs, the exchange may be disqualified. Unfortunately, there is no reset button.
Find Out if a 1031 Exchange is Right for You
Find out if a 1031 exchange is right for you by contacting the qualified intermediaries at CPEC1031, LLC today. Our team has over twenty years of experience working on 1031 exchanges of all shapes and sizes. We have the skills and expertise needed to make you feel comfortable and confident throughout the exchange process. Contact us today to learn more about the like-kind exchange process and see if your property qualifies for 1031 exchange treatment under the Internal Revenue Code.
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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