1033

Section 1033(a)(1) of the Internal Revenue Code states:

“If property (as a result of its destruction in whole or in part, theft, seizure, ort requisition or
condemnation or threat or imminence thereof) is compulsorily or involuntarily converted-into property
similar or related in service or use to the property so converted, no gain shall be recognized.”

The two most common situations are:

1. Property is destroyed by fire, earthquake, hurricane or some other destructive event. The taxpayer in these cases is normally compensated with insurance proceeds.
2. Condemnation (or threat of condemnation) of the property when:

a) Government exercise of its power of eminent domain. There must be compensation, and it must be involuntary.
b) The property owner sells due to an imminent threat of a condemnation. The property owner must be aware of the threat and must reasonably believe that a condemnation is likely to occur.

1033 has some important differences from 1031. Under 1033:

1. The taxpayer does not need to use a Qualified Intermediary. Therefore, the taxpayer can take immediate possession of condemnation or sales proceeds.
2. The timing for buying replacement property begins with the date of disposition or earliest date of the threat, whichever is earlier.
3. For real property held for productive use in a trade or business, or for property held for investment, the time limit for acquiring replacement property is:

a) Two years from the end of the tax year in which the property was destroyed (by fire, etc.)
b) Three years from the end of the tax year in which the condemnation proceeds are received.

4. In order to totally defer any taxable gain, the taxpayer needs to purchase replacement property equal or greater in value to the property lost in conversion or condemnation. The amount of cash and debt used in acquiring replacement property doesn’t matter. This is different from 1031 where all cash proceeds need to be used to acquire replacement property, and debt needs to be replaced by a new loan which is equal to or higher than the debt being retired.

Rules for Replacement Property:

1. Property lost by fire, etc. must be replaced with property which is “similar or related in service or use.” This rule is rather restrictive.
2. Property that is lost because of condemnation can be replaced by property which is like-kind just like the 1031 replacement property rule is applied. Basically, any real property acquired can qualify as replacement property. This includes a Delaware Statutory Trust (DST) interest.