The g6 regulations (from Treasury Regulation §1.1031(k)-1(g)(6)) dictate the circumstances under which a Qualified Intermediary (QI) can release 1031 funds to the client. To expand on that, here are some of the restrictions surrounding when the funds can be released, according to the IRS:
(As a reminder, an exchanger has 45 days to identify replacement property when conducting a 1031 exchange). The funds cannot be released during the 45-day identification period, even if the exchanger decides that they do not want to move forward with the exchange. If the exchanger does not move forward with the exchange and does not identify replacement property, the funds may be returned to them on the 46th day.
(An exchanger has 180 days to close on the replacement property when conducting a 1031 exchange). If an exchanger has made any replacement property identifications, the funds cannot be returned during the 180-day exchange period, even if the taxpayer decides not to close on a replacement property. After the 180 days are up, the exchange proceeds may be returned on the 181st day.
The funds may also be released if a major event occurs that is out of the exchanger’s control, such as a zoning change, regulatory approval, or destruction of the property (due to a natural disaster, etc.).
An exchanger may designate an amount of funds that they do not intend to reinvest and wish to take out of the exchange. This amount must be specified in the Exchange Agreement with the QI before closing on the relinquished property.
It is important to note that if you do not move forward with the 1031 exchange, the funds you receive from your Qualified Intermediary (commonly referred to as “boot”) will be subject to capital gains tax and depreciation recapture taxes.
As the taxpayer, it may be frustrating not to get the funds back immediately. You chose not to move forward with the exchange, and you are prepared to pay taxes on the funds, so why must the Qualified Intermediary hang onto the money for several weeks (or even months)? If the Qualified Intermediary does not follow these regulations, the IRS will consider them to be an “agent” of the exchanger, and agents are disqualified from acting as Qualified Intermediaries. If the Qualified Intermediary chooses to give you the funds before they are supposed to, they would be in violation of federal law, jeopardizing their entire business and ultimately disqualifying them from being a Qualified Intermediary.