1031 Termination: Can a Taxpayer End an Exchange at Any Time?

by Maura Snabes, Esq., CES, NTP

A taxpayer recently asked whether she could preserve the ability to defer her capital gains taxes while retaining the flexibility to withdraw her 1031 exchange funds at any time—whether before the 45-day identification deadline or, if properties were identified, before the 180-day exchange deadline.

The short answer is no. Under the Treasury Regulations, a taxpayer cannot have actual or constructive control over the exchange funds during the exchange period. To protect the exchange, the funds must be subject to the required limitations—commonly referred to in the Qualified Intermediary (QI) world as the “(g)(6) restrictions.” Without these restrictions, the exchange will fail.

Why Funds Cannot Be Released on Demand

Even if a taxpayer is willing to pay the capital gains tax, the IRS does not allow unrestricted access to exchange proceeds during the exchange period when using the Qualified Intermediary safe harbor. The Exchange Agreement must expressly limit the taxpayer’s right to “receive, pledge, borrow, or otherwise obtain the benefits of money or other property” until the 180-day exchange period ends, except as permitted by Treasury Regulation §1.1031(k)-1(g)(6).
If these (g)(6) restrictions are missing, the safe harbor is not satisfied—even if the taxpayer never actually receives the funds (Treas. Reg. §1.1031(k)-1(g)(8)).

Limited Circumstances for Early Release

Funds may be disbursed to the taxpayer before the 180-day period ends only in the following situations:

1. No Identification by Day 45
   If no replacement property is identified, exchange proceeds can be released on Day 46.
2. Exchange Period Ends
   If the taxpayer has not closed on all identified properties by Day 180, any remaining funds can be released on Day 181.
3. All Identified Properties Acquired
   After acquiring all identified properties, any excess funds may be disbursed.
4. Material and Substantial Contingency
   After the 45-day identification period, funds can be released if a contingency related to the exchange:
   • is material and substantial,
   • is provided for in writing,
   • is beyond the control of the exchanger and any disqualified person (other than the party obligated to transfer the replacement property).

Examples may include zoning changes, destruction of property, condemnation, or extended regulatory approval. The IRS applies this exception narrowly. Failed negotiations, economic infeasibility, or a simple change of mind do not qualify.

Bottom Line: If a Qualified Intermediary (QI) allows you to withdraw exchange funds at any time—even if you intend to pay the capital gains tax—beware. An IRS audit could determine that the QI failed to comply with the required (g)(6) restrictions, potentially jeopardizing not only your exchange but also exposing the QI and all of its other 1031 exchanges to significant risk.

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