Frequently Asked Questions
1. What is a 1033 Exchange?
- Originally placed in the Tax Code in 1921, Internal Revenue Code Section 1033 governs the tax consequences when a property is compulsorily or involuntarily converted in whole or in part into cash or other property. This is commonly referred to as an involuntary conversion since the loss of property is beyond the control of the taxpayer. There is no requirement under Section 1033 that a third-party accommodator—as a qualified intermediary in an IRC §1031 tax- deferred exchange—be employed to hold the conversion proceeds.
2. What is an “Involuntary conversion”?
- Under Section 1033, an involuntary conversion is defined as a destruction or loss of the property through casualty, theft or condemnation action pursuant to government powers of eminent domain, and the resulting compensation from such destruction or condemnation. [IRC Section 1033(a)].
- Even though the sale and/or compensation for the property were essentially forced on the taxpayer, the taxpayer is still liable for any capital gain tax liability on the compensation received. However, if the property is subject to an “involuntary conversion”, the taxpayer has the ability to defer the payment of the depreciation recapture and capital gain taxes on the involuntary conversion under the non- recognition provisions of Section 1033. [IRC Section 1033].
3. If I’ve already paid taxes on money I received, can I get it back?
- Under the IRC Section 1033, you have a “replacement period” during which you can change your mind. So, if you already paid the tax on a forced sale or easement and are still within your replacement period, you can still purchase a replacement property and then file an amended return for that tax year and recapture your tax
4. How long is the replacement period?
- The 1033 exchange typically gives clients two years starting January 1st the year after you received compensation for a forced sale or easement. However, if the land was used in any business purpose, you generally have three years. For example, if you had land used for farming, ranching or haying, and you received compensation in March 2014, you must close on the replacement property no later than December 31th, 2017 if you’re wanting to execute a 1033 exchange. You would then file an amended tax return for tax year 2014.
5. What are some of the major differences between the 1031 and 1033 exchanges?
- In a 1031 exchange, you are voluntarily selling a piece of property you own with no pressure from an entity that has eminent domain authority. You must identify potential replacement properties beforehand, and close on at least one of the replacement properties within 180 days after selling the initial property. You cannot take direct receipts of the sale proceeds; a third party must hold the proceeds until they are used to purchase the replacement property or properties.
- In a 1033, you do not need to identify any replacement property anytime. You have 2 or 3 years to close on your replacement property or properties depending on how the initial property was used. You can take direct receipt of the sale proceeds. You are not required to use the sale proceeds to purchase the replacement property.
6. What are some types of property that are eligible for 1031 or 1033 consideration?
- Farms, Land, Livestock, Businesses, Commercial properties and parking lots, Oil, gas and mineral interests, Water and ditch rights, Gold, silver and numismatic coins, Commercial buildings, Apartments and Condominiums, Hotels and Motels, Artwork, Rental properties, Collectibles (rugs, antiques, cars, coins, stamps, metals, gems), Conservation easements, Timberland, Communication towers, Aircraft.