Can you 1031 exchange condemned property...?

1031 Tee-Shots

The answer is a definitive NO. You cannot do a 1031 Exchange. However, you can do a 1033 Exchange! Section 1033 of the Tax Code addresses condemnations and "involuntary conversions" of property.

Let's say you own a nice piece of ocean-front property that you bought ten years ago for $200,000. It's so beautiful, in fact, that your friendly local municipality decides to take it from you and build a public park. During the course of negotiations (or court proceedings), it is determined that the City will pay you $2,000,000 for your property. As you can see, you have $1.8m of taxable gain. You'll pay 15% (or $270,000) to the Federal Government, plus whatever State taxes may be due. What now?

Well, you perform a 1033 Exchange. These are somewhat similar to 1031 Exchanges, but most of the rules are much more lenient. You still must reinvest your proceeds into a New Property just like in a 1031 Exchange. Except, for instance, instead of having 45-Days to identify and 180-Days to close, you simply must close on a New Property within two (2) years. Also, you do not need to use a Qualified Intermediary, you can touch the proceeds and not have them be taxable, and no special legal documents are required at the closing of the sale of your Old Property or the purchase of your New Property. Lastly, the same reinvestment requirements apply (buy equal or up and reinvest all cash proceeds).

There is one area where 1033 Exchanges are more restrictive. In a 1031 Exchange, you must buy "like-kind" property. This means that if you sell "business or investment" real estate, you must buy "business or investment" real estate. This standard is very broad -- you can sell a rental and buy land, or sell commercial property and buy a vacation home, and the like. In a 1033 Exchange, you must reinvest your money into property that is "similar or related in service or use." There is not much authority on what this means -- you should certainly contact your tax professional to navigate this issue. However, in general, if you sell vacant land, you should buy vacant land, or if you sell a rental house, you should buy a rental house, etc.

But, that's it -- fairly simple. Presumably, Section 1033 also applies to the destruction of your property due to a natural disaster, fire, or the like, whereby you received insurance proceeds to rebuild and acquire New Property in exchange for transferring title to your Old Property to your insurance company.

If you should have any questions on this issue or 1031 Exchanges in general, any of our Experts would be glad to help. Just shoot us a call!

--The Experts