Understanding IRC Section 1033: Tax Deferral and Reinvestment Opportunities After Property Conversions

Understanding IRC Section 1033: Tax Deferral and Reinvestment Opportunities After Property Conversions

If your property is taken by the government or destroyed and you receive a payout, you may face a large, unexpected tax bill. That’s because when insurance or condemnation proceeds exceed your tax basis, the excess is generally treated as taxable gain. Fortunately, Section 1033 of the Internal Revenue Code may allow you to defer that tax if insurance or condemnation proceeds are timely reinvested into qualifying property.”

Qualifying Property

Section 1033 deferral is only available when the proceeds from the converted property are reinvested into qualifying property or properties. Generally, to qualify, the replacement property must be “similar or related” to the converted property, meaning that it is functionally similar to and has the same uses as the converted property.

A special rule under Section 1033(g) applies when the converted property is real property held for productive use in a trade or business or held for investment. In this case, the replacement property can be of “like kind” to qualify for the deferral, a standard that is broader than the typical “similar or related” standard. While investment realty can generally replace converted business realty and vice versa under the “like kind” standard, each reinvestment opportunity should be thoroughly analyzed to ensure that the reinvestment will qualify for Section 1033 deferral treatment.

Deferral and Timing

Under Section 1033, the deferral of gain is available only to the extent the monetary proceeds received from the conversion are reinvested in qualifying property. When less than the full amount is reinvested or is not reinvested in qualifying property, gain is recognized to the extent it is not reinvested or does not otherwise qualify for the deferral. Further, the taxpayer must reinvest in the qualifying property within the required two or three year window, depending on whether the converted property was real property held for productive use in a trade or business.

With changes to the Brent Spence Bridge Corridor and the everchanging landscape of the Greater Cincinnati Area, Section 1033 could be more applicable to businesses than ever. For questions about involuntary conversions or related issues, contact Rachel E. Keathley at 513.629.9489 or rekeathley@strausstroy. She is licensed in Ohio and Kentucky.