Final regulations coordinate deferred like-kind exchange and installment sale rules.

Congress authorized the use of deferred like-kind exchange transactions for tax planning by enacting the Deficit Reduction Act of 1984. Specific time limits were established to end perceived abuses from long delays between the transfer of properties. The "identification period," which is the period allowed to identify the replacement property, was limited to 45 days from the transfer of the relinquished property (Sec. 1031(a)(3)(a)). The "exchange period," which is the period allowed for the transfer of the replacement property, was limited to the earlier of (1) 180 days after the transfer of the relinquished property or (2) the extended due date of the transferor's tax return for the tax year in which the transfer of the relinquished property occurred (Sec. 1031(a)(3)(b)). Congress has therefore allowed, with extensions and identification of replacement property, a delay of 180 days between the transfer of properties.

The taxpayer may not be in actual or constructive receipt of money and/or other nonqualified property during the exchange period. A receipt of nonqualified property by the taxpayer during this period triggers gain recognition (Regs. Sec. 1.1031(k)-1(f)(1)(a)). The taxpayer's need to protect his interest between the time he transfers property to the time he receives the replacement property can be addressed by the use of "safe harbor" security arrangements. Qualified escrow accounts and trusts (Regs. Sec. 1.1031(k)-1(g)(3)) and qualified intermediaries (Regs. Sec. 1. 1031(k)-1(g)(4)) limit the taxpayer's right to the escrowed nonqualified property and thereby prevent the cash or other nonqualified property from sabotaging the tax-free character of the exchange (Regs. Sec. 1.1031(k)-(1)(g)(3) and (4)). The taxpayer will normally (1) transfer the relinquished property directly to the other party in the exchange and require that party to fund an escrow account or (2) transfer the relinquished property directly to an intermediary who will also require the other party in the exchange to transfer cash or other nonqualifying property to him at the same time. The intermediary will subsequently retransfer the relinquished property to the other party when the taxpayer receives the replacement property.

Sec. 453 sets forth the rules for applying the installment sale method of accounting. These rules are generally favorable to taxpayers; they allow income to be recognized proportionately as installment payments are received rather than at the earlier point of sale. Final regulations have been issued that coordinate the deferred like-kind exchange and installment sale rules, amending Regs. Secs. 1.1031(b)-2 and 15a.453-1(b)(3)(i) and adding Regs. Sec. 1.1031(k)-1(j)(2). The following is a presentation in question and answer form of material covered in the final regulations:

Question #1: Is the deposit of cash or other qualified property in a qualified escrow account, trust or with a qualified intermediary considered payment to the taxpayer under the installment sale rules?

Answer #1: No. If a transaction otherwise meets the like-kind exchange rules and the taxpayer complies with the rules for setting up a qualified escrow or trust or using a qualified intermediary, the transactions will not be treated as an immediate sale.

Question #2: If the exchange ultimately fails and the taxpayer receives cash, can cash receipts be accounted for under the installment sales method?

Answer #2: Yes. If at the beginning of the exchange period the taxpayer has a bona fide intent to make a deferred exchange, then recognition of income under the installment sale method is allowed.

Question #3: What constitutes "a bona fide intent to make a deferred exchange?"

Answer #3: A taxpayer will be treated as having a bona fide intent only if it is reasonable to believe, based on all the facts and circumstances as of the beginning of the exchange period, that like-kind replacement property will be acquired before the end of the exchange period (Regs. Sec. 1.1031(k)-1(j)(2)(iv)).

Question #4: What is the treatment of installment notes received by the taxpayer on the failure of the exchange when a qualified intermediary is involved?

Answer #4: Cash receipts on the notes can qualify for installment sale treatment. Installment sale rules usually do not apply to the receipt of a note if the note does not come from the recipient of the disposed property. However, under Regs. Sec. 1.1031(k)-i(j)(2)(ii), the intermediary is ignored and the transaction is treated as if only the taxpayer and the recipient are involved.

Question #5: What are the effective dates of the regulations?

Answer #5: The regulations apply to transfers on or after Apr. 20, 1994. Taxpayers may elect to apply the regulations to transfers occurring on or after May 17, 1990, if the transfer otherwise meets- the requirements for deferred like-kind exchanges (Regs. Sec. 1.1031(k)-1(j)(2)(vii)).

Question #6: What if the taxpayer previously reported gain that now qualifies for installment method reporting under these regulations?

Answer #6: No remedy is provided. The recognition of gain on an earlier tax return constitutes an election not to use the installment method (Regs. Sec. 1.1031(k)-1(j)(2)(vii)).