TM 1031 Exchange
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Involuntary Conversion of Real Estate

In January of 2005 the Supreme Court, in a 5 to 4 decision, gave City Governments the broad power to seize private property in order to generate tax revenue. This means that property owners will have more limited rights when facing the threat of their property being condemned via “eminent domain”. Eminent domain is defined as “the power of a government to take private property for public use, usually with compensation paid to the owner”

The tax treatment of Capital Gains associated with a property that is appropriated by the government via Eminent Domain is a subject investment property owners ought to be aware of. Section 1033 of the IRS Procedural Code (aka 1033 rollover) addresses how an investor/business owner can defer payment of capital gain taxes when “involuntarily converting” its investment/business property.
  • Destruction of the property that is beyond the control of the taxpayer
  • Theft of the property
  • Seizure or requisition of property
  • Taking of the property through condemnation or eminent domain
  • Disposition of the property upon the threat or imminence of condemnation or
Eminent Domain.

The rule provides that a tax payer must make a “valid” or “timely” election by not reporting a recognized gain on your tax return for the year that the conversion took place (be sure to run this by your tax advisor as you must give details of the reason for not reporting the gain).

The Replacement Property

The rules for choosing a replacement property set forth in a 1033 rollover are very specific. The kind of replacement property you can select is narrower than under a 1031 exchange. To further complicate matters the types of replacement properties permitted are a function of wheither the exchanger was an owner/user or an owner investor. Make sure to consult with your tax advisor or real estate attorney before selecting your replacement property.

Comparing Sections 1033 and 1031

There are certain instances when a property owner will have the choice to take advantage of either one of these sections. When considering which one to employ please take note of the following:

Section 1031 provides a much larger amount of flexibility when it comes to choosing a replacement property (like kind).

Section 1033 allows 2 to 3 years to choose your replacement property (section 1031 gives 45 days to identify and 180 days to complete the sale). But be careful because this can get away from you.

Section 1033 does not require a qualified intermediary (you can take the proceeds of the sale as long as you reinvest them according to the rules within 2 to 3 years)

As with all major investment decisions it is important that they consult with their tax and or legal counsel prior to making their final decision.

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