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Comparing 1031 and 1033 Exchanges

No, that reference you skimmed on a tax-deferred exchange website about 1033 exchanges was not a typo. 1033 exchanges do exist, and they do allow real estate owners to replace one property for another while deferring capital gains taxes. 1033 exchanges, however, are not an alternative to 1031 exchanges and are not an exchange strategy you’ll likely consider including in your investment plans.

1033 exchanges benefit those real estate owners who involuntarily convert their property into cash and experience taxable gains. Involuntary conversion of real estate could include:

  • The destruction of property due to a natural disaster,
  • The loss of property due to an exercise of eminent domain, or
  • Property that is transferred as a result of condemnation.

In any of these cases, the property owner could be liable for capital gains taxes if the compensation from either the insurance company or the government agency involved in the seizure or condemnation of the property exceeds the owner’s cost basis in the property.

Though in effect, a 1033 exchange and a 1031 exchange may seem to achieve the same goal, the regulations between the two sections of the IRC code differ significantly.

Unlike a 1031 exchange, a 1033 exchange does not require the assistance of a qualified intermediary. Instead, the compensation received for the lost property can remain in the possession of the exchanger until the time a replacement property of a value equal to or greater than the compensating proceeds is purchased.

While a 1031 exchange requires the purchase of a replacement property that is considered “like-kind” to the relinquished property, a 1033 exchange requires the purchase of a replacement property that is “similar or related in service or use” to the lost property. Though these conditions are similar, the 1033 exchange requirements are stricter about the two properties serving the same purpose for the exchanger. For example, if the lost property was the exchanger’s primary residence, the replacement property must also be used by the exchanger as a residence.

A 1031 exchange has a 180-day exchange period. In contrast, 1033 exchanges have a much longer allowance of time for completion. In most cases, the replacement period is two years. However, in the case that the lost property was held for productive use in a business, trade, or for investment, (such as a rental property or office building), the replacement period is extended to three years. If you are in a situation where your property was destroyed in a presidentially declared disaster area, the replacement period is extended to four years.

The first day of the 1033 exchange replacement property is determined by the earlier of 1) the date when the property was destroyed or 2) the date when the threat of property condemnation or seizure occurred. The deadline for the replacement period is two years (three or four years, as discussed above) after the end of the first tax year when any part of the gain was realized by the property owner.

One final difference worth mentioning is that 1031 exchangers must abide by the 45-day identification period. 1033 exchangers, on the other hand, do not have to declare candidate properties prior to acquiring a replacement property.

There are many other differences between these two exchanges. If you have experienced a situation that would qualify you for a 1033 exchange, we recommend working with a tax advisor to understand all of the 1033 exchange benefits and requirements.

While the information provided above has been researched and is thought to be reasonable and accurate, 1031 Crowdfunding are not lawyers or tax professionals. It’s important to consult with a licensed tax professional regarding your personal tax situation.

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