Q: I own investment property that was involuntarily converted, and will be receiving proceeds resulting in a substantial gain.Â 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.Â There are many horror stories of how taxpayers
have lost enormous benefits by the improper handling of 1031
exchanges.Â And transaction accommodators haveÂ become a mainstream
business in order to ensure this doesnâ€™t happen.
Another source of concern might be the
sheer size of some 1033 exchanges, often involving property worth
millions of dollars.Â Iâ€™d say thatâ€™s an excellent reason to want to get
things right, and Iâ€™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).Â That's because restrictions for custody of funds are nearly
nonexistent in comparison to 1031â€™s, though time periods are still quite
important.Â As you will note in the tax code itself (hereâ€™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.Â Thatâ€™s
a matter for your CPA.
And that takes me to Part I of my best advice for my clients on this matter: Â Â 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.
Itâ€™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.Â But often they have not gotten
specifically involved in 1033 exchanges, and I believe thatâ€™s because
thereâ€™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.Â 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 1031â€™s and
1033â€™s, I highly recommend that you contact the following professional
for an hour's consultation :
Chad R. Turner, CPA, PFS
Chadâ€™s a bright guy with a successful tax
practice in Torrance.Â He's one of two advisors I phoned myself for
their thoughts onÂ this matter.Â - David