You could be familiar with Section 1031 of IRC that allows investors to defer capital gains taxes on exchanging like-kind properties. But, what about Section 1033? Well, it’s certainly not a typo, but an entirely different section of IRC. Like 1031 Exchanges, a 1033 Exchange allows investors to defer capital gains taxes on exchanging like-kind properties. However, this is the only similarity between Section 1031 and Section 1033. Otherwise, both sections are entirely different from each other. But before we figure out the differences between both sections, it’s important that you understand Section 1033 thoroughly.
1033 Exchanges are mostly done in case of eminent domain or property loss.
1033 Exchanges allow investors to defer capital gains taxes on exchanging like-kind properties. However, unlike a 1031 Exchange in which an investor willingly exchanges out one property for another, a 1033 Exchange takes place when an investor involuntarily loses their property. In other words, a 1033 Exchange is only possible in case of the involuntary conversion of the property. Therefore, an investor can take advantage of a 1033 Exchange only if the old property was lost due to any of the following reasons:
- Disasters such as earthquakes, hurricanes, or fire.
- Theft (in case of movable properties)
- Seized by the State or federal government under eminent domain.
The first two scenarios are quite obvious. Let’s take the case of eminent domain. Basically, eminent domain is a power using which a State or Federal government can force an investor to relinquish their property for public use. In return, the government is only liable to pay the fair market value of the seized property to the investor. Though 1033 Exchanges do provide the benefit of tax deferment, however, it may not be the best option, as property loss can’t please any investor. Therefore, an investor shouldn’t initiate a 1033 Exchange until they are aware of the threat of losing their property. This is one of the areas where 1033 Exchanges differ entirely from 1031 Exchanges. Now, let’s find out other major differences between these two exchanges.
1031 Exchange Vs. 1033 Exchange
- 1031 Exchanges require investors to identify potential replacement properties within 45 days from the closing date of the relinquished property (Identification Period). However, there is no identification period in 1033 Exchanges. Therefore, 1033 Exchange investors can directly acquire replacement properties without identifying them at first.
- In 1031 Exchanges, investors are required to acquire replacement properties within 180 days. Whereas 1033 Exchanges are more lenient when it comes to deadlines. 1033 Exchange investors usually get two years for acquiring replacement properties, which may extend up to three years. Moreover, in case an investor loses their property in a presidentially declared disaster, then the deadline to complete the exchange extends to four years.
- If you’re doing a 1031 exchange, you must hire a Qualified Intermediary. Whereas, 1033 Exchange investors aren’t required to hire Qualified Intermediaries. Therefore, they also have complete control over the proceeds of the relinquished property, which doesn’t happen with 1031 Exchange investors.
- In 1031 Exchanges, the term like-kind is used to define properties that are similar in nature. For example, any income-producing property can be exchanged for another income-producing property in 1031 Exchanges. However, in 1033 Exchanges, the term like-kind is used to define properties that are used for similar purposes. For example, if the relinquished property had a retail shop built upon it, then the replacement property must also be a retail shop.
There is no doubt that 1033 Exchange investors don’t have to bear the pressure of stiff deadlines. However, it’s also true that barely any investor would want to lose their property in the first place. That’s the reason why 1033 Exchanges aren’t much popular among investors despite the benefits that it offers. However, in case you’ve already received the threat of property seizure, then you should definitely plan a 1033 Exchange without any hesitation.
Interested in doing a 1031 Exchange? Get help from 1031 experts.
If you own a non-performing asset and want to trade it for new investment options, it’s beneficial to do a 1031 exchange on that property. You can reinvest your 1031 proceeds in different property types like a multi-family apartment, student housing, office space, etc.
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