For years Qualified Intermediaries (QIs), like ourselves, have been concerned that an accidental mistake could derail a good 1031 exchange. Like a settlement agent sending the proceeds from a settlement directly to the seller, when the instructions from the QI clearly told the settlement agent to send the funds to the Qualified Escrow Account at a bank.

While the main thrust of the case addressed another issue, in the case Morton v. United States, of April 27, 2011, in the Court of Federal Claims, the judge made a common sense ruling that accidental 1031 exchange mistakes that are quickly corrected do not void a 1031 exchange.

In the closing of the relinquished property, the settlement agent accidentally and in contravention of the escrow agreement wired funds from the escrow account directly to the taxpayer. The funds were returned to the QI the following day.  The Court held that an accidental transfer followed by an immediate return of funds does not constitute actual or constructive receipt. The court concluded that while Morton had complied with all the other 1031 exchange requirements, he validly effected a deferred 1031 like-kind exchange.

Additionally, the Court held that the taxpayer should not be penalized for another’s mistake when he took every step to validly affect a deferred 1031 like-kind exchange.

As one 1031 expert stated, this case is important for situations where there is a mistake in the closing of an exchange.  Prompt correction of the error and proper documentation can apparently save the day.