Most real estate companies are familiar with the Section 1031 like-kind exchange.
See also Real Estate
However, there is another type of real estate exchange, Section 1033 exchange, that can be used by certain property owners. A 1033 exchange is available to those who have had their property condemned under eminent domain or because of natural disasters such as fire, tornado or theft. In this situation, the taxpayer can leverage a 1033 exchange to receive similar tax deferral benefits as offered under a 1031 exchange. The good news for taxpayers in this situation is the rules governing 1033 exchanges are far less stringent than those for a 1031 exchange. To help clients, prospects and others understand 1033 exchanges and their benefits; Hanson & Co has provided a summary below of key points.
What is a 1033 Exchange?
A 1033 exchange permits a real estate owner to defer capital gains taxes on proceeds earned from the forced sale of property. A 1033 applies only to properties that have undergone involuntary conversions, which means property that has been condemned because of eminent domain, or unforeseen natural disasters (fire, earthquake, flooding or hurricanes) or other destruction.
Key Details of a 1033 Exchange
Definition of Condemnation – Many property owners are surprised to learn that just the threat of condemnation is a qualifying event under which a 1033 exchange may be implemented. The IRS requires that the taxpayer have reasonable grounds to believe that if the property is not sold it will be condemned. If the property is sold to someone else other than the condemning authority the transaction is also eligible for the exchange. There are many options and opportunities to be considered by the property owner.
Qualified Intermediary Requirement – Under a 1031 exchange the selling property owner must hire a Qualified Intermediary to hold funds between the time the initial property is sold and the replacement property is purchased. However, under a 1033 exchange no such requirement exists. Property owners can hold the funds from the condemnation of property and use them for the acquisition of the replacement property. Since the taxpayer takes possession of the funds they can invest that money in short term investments which is simply not an option under a 1031 exchange. It’s important to note that if all proceeds from the involuntary conversion are not used then they are eligible for taxation.
Identification Requirement – Under a 1033 exchange, there is no time period within which a replacement property needs to be identified. This means that a property owner has quite a bit more time to identify a replacement property than those using the 1031 exchange which requires a replacement property to be identified within 45 days. It’s clear that IRS is more lenient because involuntary conversions are often unexpected and more time is needed for planning,
Replacement Timeframe – The replacement period for 1033 exchanges is much longer than 1031 exchanges. A taxpayer has 2 years in which to acquire a replacement if the property was destroyed due to natural disaster and 3 years if it was condemned by government agencies. It’s important to note since there are often delays in payment once a property has been condemned by the government or by an insurance company, the replacement period begins once the taxpayer receives payment. So there is ample opportunity for the impacted taxpayer to search and find an ideal replacement property.
A 1033 exchange is a useful tax planning tool that offers many benefits to real estate owners. While the rules and regulations governing these exchanges can be complex, it’s a useful tool that should be considered. If you have questions about the 1033 exchange process or would like assistance with other real estate accounting issues, Hanson & Co can help. For additional information please contact us at (303) 388-1010, or click here to contact us. We look forward to speaking with you soon.