1033 Exchange Rules
Many individuals know that Section 1031 of the Internal Revenue Code allows for the deferral of gains or losses for income tax purposes in connection with the exchange of "like-kind" real property (and specific personal property) held for investment or business purposes.
Pertaining to this, only a few are aware of the Internal Revenue Code provision applying to involuntary real property conversions, such as during property loss due to destruction. The "1033 Exchange" follows the guidelines of IRS Section 1033, thus the term.
What is a 1033 Exchange?
Similar to a 1031 exchange, in which capital gains are deferred through the purchase of like-kind property, the investor can defer capital gains tax from a forced conversion due to property damage or natural disaster through a 1033 exchange. In relation to this, unlike 1031 transactions, the time constraints and tax deferral requirements of 1033 swaps are often far more elastic and favorable to the taxpayer.
1033 Exchange Rules- What you need to Know
Real estate investors must strictly adhere to the following rules while carrying out a tax-deferred 1033 exchange:
- Usage- Compulsory or voluntary exchange of property is subject to its eminent domain, theft, or destruction status.
- Replacing Equity through the "Equal and Up Rule”- The value of the debt on the new property has to be equal to, or more than, the amount of the debt based on the property conversion (cash).
- Replacement Property Standard- The exchange real estate asset must be similar/related in use or service to the relinquished property.
- Exchange Timelines- A 1033 exchange is only considered final once an actual qualified replacement property purchase has occurred and the title has been transferred to the investor. There must be more than an enforceable contract to meet the real property exchange deadline.
- Constructive Receipt- The escrow on one or more qualifying replacement properties must close within two years after the close of the first tax year in which the gain is recognized. Moreover, this replacement period can be extended to three or four years under certain circumstances.
- Appropriate Vesting- The same entity/individual holding title to the sold investment property must purchase a like-kind replacement property.
- Other Rules- The investor can use the exchange proceeds from the involuntary conversion to improve the owned property. Generally, the investor cannot acquire the replacement property from "related" parties.
No Need For a Qualified Intermediary for Your 1033 Exchange
The 1033 exchange provides a lot more leeway for how an investor might use the proceeds from forced conversion. In 1033 exchanges, the investors are entitled to instant rights and access to the profits from their investment, personal bank, and money market accounts.
At no stage is a competent intermediary required for a 1033 transaction. Until the closure of escrow for 1033 replacement assets, the property owners can invest the money in shorter-term investments, if necessary.
Pivot Professional Partners – Your Dedicated 1033 Exchange Advisor
We recommend that investors take the full benefit of the increased timeline of a 1033 tax deferred exchange to remove the pressure that can occur in a 1031 transaction. Investors should adopt a proactive approach that helps put their capital investment back to work in suitable replacement properties that align with their real estate investment objectives.
The Pivot Professional Partners team of professionals has decades of cumulative experience handling the most difficult 1033 exchange scenarios. With our help, the property owner can keep much more of their settlement monies from the converted property without paying capital gains taxes, thanks to the 1033 exchange solutions we recommend.
You can schedule a consultation with the Pivot Professional Partners’ team through this Contact Us form to plan your 1033 exchange. If you prefer to discuss your requirements regarding the exchange process over the phone, feel free to speak with our experts at (561) 444-3371.
While a 1033 is considered a tax strategy, we are not tax advisors, and you should consult your tax professional before investing.