When taxpayers think about the replacement of one investment real estate property with another, the conversation generally centers around the popular 1031 exchange, the commonly used name for exchanges of property covered within Internal Revenue Code (IRC) section 1031. However, a second option is available within IRC section 1033, known as an Involuntary Conversion, that is especially valuable to taxpayers who have fallen on unfortunate times. With the recent Internal Revenue Service-designated Disaster Situations, including IA-2020-05, tax relief for Iowa derecho victims, CA-2020-06, tax relief for California wildfire victims and LA-2020-03, tax relief for Hurricane Laura victims, Section 1033 is a great option for real estate owners with lost or destroyed property to get back on their feet financially by deferring the tax consequences of any relief, whether insurance proceeds or government aid, that is received.
Determination of Qualifying Property
Unlike a 1031 exchange that results in the sale of appreciated property to an outside buyer, a 1033 involuntary conversion arises either as a result of casualty, theft, seizure or condemnation of property and a subsequent realized gain as a result of insurance or condemnation proceeds received. After the loss of property and the insurance or condemnation proceeds have been received, taxpayers must determine whether the replacement property qualifies within the limitations of Section 1033 and qualifies for tax deferral of any calculated gain. There are a variety of types of property that qualify, with the most common being property similar or related in service or use as the property converted. This is a fairly easy threshold to overcome as, more often than not, in the case of an involuntary conversion of real estate, the proceeds received are used either to replace the property lost directly or acquire a similar property to continue the investment.