A Section 1033 eminent domain and a Section 1031 exchange achieve the same outcome of deferring capital gain taxes when selling real property, but one is far less restrictive than the other. Section 1033 does not require a Qualified Intermediary (QI) where in a Section 1031 exchange a QI is required with the exception of a two-party exchange. In a Section 1033, the taxpayer can receive the sales proceeds and hold them until the replacement property purchase. If not all the proceeds are used towards the acquiring the replacement property, the taxpayer is taxed on the difference. In addition, replacement property cannot be acquired from a related party. Section 1033 applies when the relinquished or current real property is sold due to condemnation or a threat of condemnation.
An example of a Section 1033 condemnation is when the state wants to acquire your land or property for road improvements or development. Commercial property owners are typically the parties receiving the notice to acquire their properties from the state and often from the Department of Transportation. It is important to secure a letter from the condemning party that reflects their authority to condemn and if the property is not sold willingly, the property will be condemned. Finally, the letter should clearly indicate the signor is authorized on behalf of the condemning entity.
IRC 1033 Functional Use Standard
In a Section 1031 exchange, the relinquished property is replaced with “like-kind” property within 180 calendar days post-closing. The taxpayer cannot have access to the exchange funds. In a Section 1033, the taxpayer decides to use one of two standards for the type of replacement property. The first choice is that the replacement property must have the same functional use of the property condemned. Land must be exchanged for land, rental must be exchanged for a rental and commercial property held in a business must be exchanged for property held for business use. Land already owned by the taxpayer can be improved with Section 1033 proceeds. “The replacement property must be acquired during the period that begins from earlier of the date of the disposition or of the threat or imminence of condemnation of the converted property, and ends two years after the closed of the first taxable year in which any part of the gain upon the conversion is realized,” per IRC Section 1033(a)(2)(B).
IRC 1033 Like-Kind Use Standard
Similar to the “like-kind” standard in Section 1031, this method can also be chosen to define the replacement property in a Section 1033. “Like-kind” means property held in the productive use of a business or for investment is to be replaced with property held in the productive use of a business or for investment. Under “like-kind” standard, “the replacement property must be acquired during the period that begins from the earlier of the date of the disposition or the date of the threat or imminence of condemnation of the converted property, and ends three years after the close of the first taxable year in which any part of the gain upon the conversion is realized,” per IRC Section 1033(g)(4).
Section 1033 is similar to Section 1031; however, the taxpayer is permitted to hold the exchange proceeds — no QI is required — and reinvest using one of two standards within two or three years.
To learn more about 1031 exchanges, review the following articles:
If you have a specific question, click on the button on the right hand side of the page for a response from the Certified Exchange Specialist on staff. Download a 10 point 1031 exchange checklist by clicking here. If you have a comment, we would enjoy hearing from you. If you have any questions, feel free to reach out to us via the options on the top right of this page, call our office at 800-227-1031 or contact us via email here
