This Free for All Friday looks at interest earned on 1031 exchange funds. Many do not realize one of the safe-harbors provided in the 1031 regulations allow an exchanger to earn a growth factor or interest on their 1031 funds while held by the Qualified Intermediary (QI).
Unfortunately, interest rates are at a historically low rate but in the past, exchangers have earned significant dollars during the 180-Day Exchange Period. Some QIs do not pay any interest on the exchange funds and some base it on the amount of the deposit and/or how long the funds will be held. Unless a client opts for a non-interest bearing account with 100% FDIC insurance (on accounts larger than $250,000), all 1031 CORP. earn interest on their exchange funds. Most of our clients can even see the interest accrue daily when they log on to the bank’s website.
The earnings must be restricted in the same manner as the principal to avoid actual or constructive receipt and thus a taxable event. The exchanger can choose to invest the interest earnings in the replacement property or have the earnings paid directly to the exchanger after the exchange is complete.
The interest earnings are taxed as any other interest earned by the exchanger regardless of whether they are invested in the replacement property. The exchanger will receive a Form 19099-INT reporting the interest earnings. If the 1031 exchange spans two calendar years, a Form 1099-INT will be issued for each year.
If a 1031 CORP. client used one of our preferred financial institutions, the Form 1099-INT will be mailed directly from the bank. If our client requested an alternative bank be used, the Form 1099-INT will likely be mailed from 1031 CORP. unless the bank has an escrow product designed specifically for 1031 exchange accounts that enables them to send it directly to the exchanger.
Over the years, 1031 CORP. has seen the majority of exchangers use the interest earnings for the acquisition of the replacement property. However, we have seen some exclude the interest for a variety of reasons, everything from using the interest earnings to start an operating account for the replacement property to a family vacation. The great thing is the choice belongs to the exchanger.
Our Exchange Team is happy to discuss this with you. Contact us any time!
