On May 24 of this year, I discussed how some taxpayers suffered economic losses in a Section 1031 exchange when funds or property were held for them by Qualified Intermediaries that went bankrupt. In letters sent by the IRS to a Senator and a Congressman, the has IRS indicated that even though like-kind exchanges run through such Qualified Intermediaries could not be completed due to the bankruptcy of a Qualified Intermediary and not through any fault of the taxpayers, the taxpayers still need to recognize gain (if there is gain) if the property they contributed to the exchange was disposed of by the Qualified Intermediary.
The IRS noted that losses for lost funds and/or replacement property may be allowable under Section 165(a) in the year the loss is sustained. Thus, there may be an available offset for any gain that arises, depending on when the loss is evidenced by closed and completed transactions and fixed by identifiable events. However, if the loss occurs in a different tax year, a mismatch of gain and loss can occur.
The IRS did indicate, however, that it is "considering the tax policy implications of current law and evaluating the scope of [its] authority in this area to issue administrative guidance.” Therefore, it is possible that some direct relief may ultimately be issued by the IRS (presumably including the ability of the taxpayer to not have to recognize gain on the initial disposition, or at least measure gain and loss by the actual consideration received back).