The §1033 Roll-Over Exchange If a taxpayer loses their property through an "involuntary conversion", Section 1033 of the Internal Revenue Code can provide relief. An involuntary conversion occurs when property is destroyed (i.e. fire, flood or hurricane as examples), stolen, condemned, or disposed of under the threat of condemnation, and other property or money is received in payment.
In particular, government entities often find it necessary to acquire property, sometimes against the wishes of the property owner. Here in Florida, hurricanes also provide a real threat to our existence and often produce an involuntary conversion to the owner. If a taxpayer has a gain as a result of an involuntarily conversion, he or she may elect to postpone recognition of the gain by buying a qualified replacement property within a specified time. The tax deferral provisions of §1033 are, in many ways, more generous to the taxpayer than the §1031 rules. For instance, §1033 provides that a taxpayer has a period of two to three years to roll over the proceeds into a new investment that is "like-kind" in most cases. Under this special rule, conversion of real property into "property of like-kind" to be held for either business use or investment is considered a conversion into property "similar or related in service or use" and qualifies for §1033 treatment. The term "real property" as used here means land and anything attached to it.
With §1033, all qualified real estate is like-kind with all other qualified real estate. This like-kind test is the same as §1031 exchanges and it does not matter if your condemned property or your replacement property is improved or unimproved. As a result, a Tenant-In-Common (TIC) Fractional Ownership Interest can qualify as replacement property. TIC's are a viable alternative for taxpayers who wish to convert management intensive property into passive income. Nace Cohen of 1031 Exchange Connection is securities licensed and a registered representative with Welton Street Investments, LLC, and can assist you with this alternative. Contact Nace for more information. Keep in mind that the IRS also treats the following, when condemned, as like-kind property if held for use in business or for the production of income:
- Easements
- Rights-of-way
- Leaseholds for a term of 30 years or more. The term includes the initial term of the lease and all optional renewal periods
- Perpetual water rights, if they are considered real property rights under state law
- Any similar continuing interests in real property
Corporate Stock as Replacement Property It is not necessary to make a direct purchase of the qualified property. The taxpayer can qualify by buying stock in a corporation owning qualified replacement property. However, the taxpayer must buy a controlling interest. The term control means ownership of 80% or more of the total combined voting power of all classes of stock entitled to vote and 80% or more of the total number of shares of all other classes of stock of the corporation. The Replacement Time Period With investment real estate , §1033 (g) allows up to three (3) years to replace the property. With a principal residence and most everything else, you have two (2) years to get it replaced. If you lost your principal residence in a "presidentially declared disaster", such as in a hurricane, there's a special extension rule that allows up to 4 years to replace your principal residence. Or, you could use the principal residence exclusion if your gain is less than $250k, or $500k if you're married, and you meet the requirements of §121.
Holding of the Cash Proceeds One of the advantages of §1033 is that a Qualified Intermediary (QI) is not required to hold the proceeds during the replacement period. This ensures the taxpayer will have full control of their money during this critical time. However, the taxpayer may want to hire a experienced consultant to assist them with this process. With us, we hold your money in an FDIC insured and segregated demand account that earns interest for the taxpayer. The account is in your name and with our bank partner, Wachovia Wells Fargo, we have a program where we can insure the proceeds beyond the 250k FDIC amount by simply foregoing the interest on account. The rules of §1033 are quite complex. Therefore, it is very important that you not rely on the information presented here but rather discuss tax and legal matters with your CPA, attorney, or other qualified person. If you are in need of more information or have questions regarding Involuntary Conversions, call us and we'll take you through it.
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