The involuntary conversion rules of IRC §1033 permit taxpayers who sell business or investment real estate under the threat of (or imminence of) condemnation to defer the gain on the sale. The IRS' position is that the threat of (or imminence of) condemnation exists when the taxpayer learns through a reliable source that a governmental or quasi-governmental entity has decided to acquire the taxpayer's property, but only if there are reasonable grounds to believe that the condemnation will actually occur.
The threat or imminence of condemnation thus exists if a taxpayer is faced with the alternative of either selling the property to the government, a quasi-governmental entity, or a third party; or having the property condemned. If there is any doubt about it, get a "friendly threat" letter from the governmental entity that is negotiating to buy your property that they will condemn it if necessary.
What Is The Replacement Time Frame?
The replacement time frame for business or investment real estate commences with the threat of condemnation and ends on the third anniversary of the end of the year in which the sale closing took place (IRC §1033(g)(4)).
What Is Qualified Replacement Property?
Qualified replacement property for business or investment real estate is any other real estate or real estate interest which is used for business or investment (IRC §1033(g)(1)). This rule is similar to the "Like Kind Property" rule of IRC §1031 concerning tax-deferred exchanges of real estate. The replacement property may be improved or unimproved under these rules. It is even possible to construct improvements on land a taxpayer already owns.
Does The Sale Cash Have To Be Escrowed Anywhere Under §1033?
There are no requirements for escrowing cash received from a condemnation sale under §1033. Taxpayers can use the cash as they wish. The replacement property can be 100% financed without using any of the cash received from the sale of the condemnation property. There is no requirement to use the condemnation sale cash for closing on replacement real estate.
How Do I Make A §1033 Election and Report A Condemnation Sale On My Tax Return?
The condemnation sale should be reported on Form 4797 and the gain should be noted as "deferred under §1033." This will comply with the requirements for making an election to defer gain under §1033 as well as comply with the reporting requirements.
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