Generally, gain or loss from the sale of property must be recognized by the seller. However, Internal Revenue Code Section 1033 allows a seller to defer any gains if the sale was due to an involuntary conversion.
Any involuntary conversion occurs when property is destroyed, stolen, condemned, or disposed of under the threat of condemnation, and other property or money is received in payment. The provisions of Section 1033 are more liberal than the rules in Internal Revenue Code Section 1031, which apply to voluntary like-kind exchanges. Under Section 1033, the seller can receive cash directly from the buyer and there is no requirement that a qualified intermediary be used. Section 1033 also provides for a longer period for the taxpayer to find and purchase replacement property (2-4 years instead of 45 days under § 1031).
To elect Section 1033, the taxpayer omits the gain from the sale from his/her tax return for the year of the sale. When the property is later replaced all the details in connection with the conversion are provided on the return for the year of the replacement. These details include what replacement property was acquired, the date it was acquired, and its cost.
Failure to purchase a replacement property within the replacement period will terminate any Section 1033 election and make all the gain on the sale fully taxable. A taxpayer must replace the property within two-four years. Generally, the replacement period begins upon the earlier of: 1) the date the property was condemned, stolen or destroyed; or 2) the date the property is first subject to threat of condemnation or seizure.
Replacement of the converted property must be completed by the end of the replacement period. Merely exerting best efforts or having construction in progress will not satisfy the requirement. The taxpayer can generally replace converted property with any like-kind property. Like-kind under Section 1033 is fairly broad. However, not all converted real property qualifies as like-kind.
Only property that is held of productive use in a trade or business or for investment is eligible for like-kind treatment.
The taxpayer must show that he/she intends for the replacement property to serve as a replacement for the converted property. You must make sure to document that the new property is being bought as a replacement or otherwise the IRS may attempt to tax the gain.
If your property has been subject to any type of an involuntary conversion and you receive other property or money in payment you should consult with your attorney to see if you can use the tax deferral ability of § 1033. Remember that § 1033 is not just available for land or buildings; it can be used for any property used in a trade or business that is involuntarily converted, including livestock, airplanes and equipment.
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