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What is a 1033 exchange? A 1033 property exchange occurs when a property is lost through circumstances outside of the owner’s control (theft, casualty, condemnation), and a replacement property is acquired. Involuntary conversion can then result in gains for the owner, but only when qualified 1033 properties are located.
Why make a 1033 exchange? By finding eligible 1033 properties, an owner can defer gains on the exchange. However, there are limitations on the type of property that can replace the original. A 1033 property exchange is easier to comply with than a 1031, but it is still important to consult a CPA or tax advisor when searching for compliant 1033 properties. An involuntary conversion can come as a surprise, but it also creates a unique opportunity to realize gain when handled carefully. Some instances of involuntary conversion might include:
Timing is everything with 1033 properties. In order to qualify for the 1033 exchange under the IRC Section 1033, the owner has 2 years (beginning on the earliest notice of casualty, theft, or condemnation) to locate adequate 1033 properties. The exception to this rule is: 1) the property was held by the owner for trade or investment, resulting in a 3-year time period, or 2) the property was the owner's primary residence and was lost due to a federally-declared disaster. In this case, the owner has 4 years to locate potential 1033 properties for exchange.
Once eligible 1033 properties have been located, it is very important to ensure that the new property is “similar or related in service or use” as the original property. In this instance, the 1033 exchange is more stringent than the 1031. For example, if the property lost was a rental, you will not be able to use the newly acquired property for your own retail space. When deciding on which of the 1033 properties you are going to purchase, it is important to be in compliance with the IRS section 1033 so you can take advantage of the potential gains. There are instances when these requirements can be loosened, usually when property was used for investment or trade. If this is the case, requirements become similar to that of IRC Section 1031, falling under the “like kind” classification.
With a 1033 exchange, the owner of the property is able to hold all proceeds until a replacement property is located and acquired, sometimes up to 4 years. Unlike a 1031, no intermediary is required with the 1033 exchange. With a longer timeframe and possibility for extension, locating 1033 properties can help transform a loss into a substantial gain for the property owner. Before making a decision about potential 1033 properties to acquire in place of lost property, find a professional who is experienced and knowledgeable in involuntary conversion and can help ensure you are in compliance with all IRS requirements.