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David J. White's Blog

By David J White | Agent in 90266

1033 (not 1031) Exchange Considerations (Involuntary Conversions)

Q: I own investment property that was involuntarily converted, and will be receiving proceeds resulting in a substantial gain.  What do I need to know to be sure I can defer the taxation of that gain under Sec. 1033 tax-deferred exchange?
A: After spending the better part of a day looking into the matter for a current client conducting a large 1033 exchange of real property, my considered but inexpert opinion is that there is little if any specialized expertise required for an escrow company to carry out its role in a 1033 exchange (meaning an exchange to defer taxation upon the involuntary conversion of an investment property).

Perhaps one might be concerned because 1031 exchanges (to defer taxation when one investment property is exchanged for another) can be quite complex, such that exactly the right steps with respect to custody of funds and property replacements must be performed by exactly the right parties, else the tax-free status of the exchange is easily lost.  There are many horror stories of how taxpayers have lost enormous benefits by the improper handling of 1031 exchanges.  And transaction accommodators have  become a mainstream business in order to ensure this doesn’t happen.

Another source of concern might be the sheer size of some 1033 exchanges, often involving property worth millions of dollars.  I’d say that’s an excellent reason to want to get things right, and I’m determined to help you achieve that if you work with me to purchase the replacement property(ies).

But 1033 exchanges are quite different from 1031 exchanges. For one thing, no accommodator is required (or available to coach an escrow company through the process).  That's because restrictions for custody of funds are nearly nonexistent in comparison to 1031’s, though time periods are still quite important.  As you will note in the tax code itself (here’s Sec. 1033 on Findlaw: http://codes.lp.findlaw.com/uscode/26/A/1/O/III/1033), the key is properly reporting the involuntary conversion in the first place (and any potential gain involved therein); then what has been done to replace the real property which was involuntarily converted.  That’s a matter for your CPA.

And that takes me to Part I of my best advice for my clients on this matter:   Please consult with your CPA and obtain any guidance or requirements he or she may offer with respect to your 1033 exchange property acquisitions, and please supply that information to me and to the escrow company so that we can be sure to satisfy these needs.

It’s important to note that some escrow companies are very experienced with traditional 1031 exchanges, and are therefore called upon to facilitate other types of exchanges (such as reverse or deferred exchanges) as well.  But often they have not gotten specifically involved in 1033 exchanges, and I believe that’s because there’s really little of anything for them to do differently than would be expected for any other traditional purchase of commercial property. Another reason is that 1033 exchanges, occurring as they do following involuntary exchanges, are simply less common than 1031's.

Part II of my recommendation, therefore, is to work with a professional Realtor with a good feel for the tax code and experience in exchange transactions in order to achieve successful transactions and avoid really costly surprises.

If your CPA is experienced in exchanges, that's a crucial point of contact as mentioned above.  If not, or if you would like to consult with a qualified CPA (other than your normal tax preparer) experienced in real estate transactions including 1031’s and 1033’s, I highly recommend that you contact the following professional for an hour's consultation :

Chad R. Turner, CPA, PFS

Chad’s a bright guy with a successful tax practice in Torrance.  He's one of two advisors I phoned myself for their thoughts on  this matter.  - David

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