1031 vs 1033 Exchange: Voluntary Sale Rules Against Involuntary Conversion Rules

Which statute applies is decided by why the property left your hands, not by what you call the deal

Section 1033(a) covers property 'compulsorily or involuntarily converted' through destruction, theft, seizure, requisition or condemnation, or threat or imminence of one. Section 1033(a)(2)(E)(ii) brings in a sale 'under threat or imminence of requisition or condemnation', so a negotiated sale to a highway authority that has said it will condemn is an involuntary conversion even though you signed a contract.

Everything else, including a sale prompted by a rezoning you dislike or a tenant leaving, is voluntary and can only be deferred under section 1031. Publication 544 adds one bridge: a voluntary sale of property that formed one economic unit with condemned property can be treated as a forced sale if the condemned part cannot reasonably be replaced.

When both regimes are available, as with a sale under threat of condemnation, you can run the replacement through either. The rest of this page is about choosing. Our answer on condemned or destroyed property covers the section 1033 rules in more depth.

Time is the biggest difference: 180 days at most against two to four years

A deferred 1031 exchange has a 45-day identification period and an exchange period that ends at the earlier of 180 days or the due date, with extensions, of your return for the year of the transfer, as Reg. section 1.1031(k)-1(b) sets out. Neither clock can be extended for market conditions.

Under section 1033(a)(2)(B), the replacement period starts at the earlier of the disposition or the first threat of condemnation and ends two years after the close of the first tax year in which any part of the gain is realized. Section 1033(g)(4) makes it three years for condemned real property held for business or investment, and section 1033(h) makes it four years for a main home in a federally declared disaster area. Publication 544 explains that a cash-basis owner realizes gain when payments exceed basis, including amounts withdrawn from a court deposit.

The 1033 period can also be extended. Publication 544 lists the details the IRS wants in a written request and notes that extensions are usually limited to one year and are not granted because replacement property is expensive or scarce.

Money handling: 1031 forbids touching the proceeds, 1033 assumes you will

In a deferred 1031 exchange, actual or constructive receipt of the sale money ends the exchange, which is why the proceeds go to a qualified intermediary under the safe harbor in Reg. section 1.1031(k)-1(g). A condemnation award, by contrast, is paid to you, and section 1033(a)(2)(A) is written around 'conversion into money'.

That freedom has a cost. The test for full deferral under section 1033(a)(2)(A) is that the replacement costs at least the amount realized on the conversion. Publication 544 says amounts a condemning authority pays straight to your mortgage holder are part of the award, so a $200,000 award with $50,000 sent to the lender is still $200,000 realized. Any shortfall below the amount realized is taxed.

Under section 1031 the comparable tests are on value and debt: Reg. section 1.1031(d)-2 treats debt relief as cash received unless offset by debt on the replacement or added cash. The two statutes reach a similar place by different arithmetic, so model each one separately.

What you can buy: the like-kind standard is broader than similar use, except after a condemnation

Section 1031 allows any real property held for business or investment in exchange for any other, so a rental house can become land, a warehouse or a Delaware Statutory Trust interest. Section 1033 normally requires property 'similar or related in service or use', a test the courts and the IRS apply to how the owner used the property, which is narrower.

Section 1033(g)(1) closes the gap for one case: real property held for business or investment that is seized, requisitioned or condemned, or sold under threat of it, may be replaced with like-kind property. A fire, storm or theft does not get that rule, except that section 1033(h)(2) treats any tangible business property as similar after a federally declared disaster.

Section 1033 also lets you buy at least 80% control of a corporation owning similar property, which section 1031 does not, although section 1033(g)(2) and Publication 544 bar the three-year period and the like-kind rule for that route.

• Condemned rental or commercial building: like-kind under section 1033(g), three-year period, no intermediary.
• Building destroyed by fire: similar or related in service or use, two-year period from year-end of realized gain.
• Voluntary sale: like-kind real property, 45 and 180 days, intermediary required.

Where a DST fits: likely after a condemnation of investment real estate, harder after a casualty

Rev. Rul. 2004-86 treats an interest in a properly structured Delaware Statutory Trust as an interest in the underlying real estate for section 1031. Because section 1033(g)(1) imports the like-kind standard for condemned investment real property, a trust interest is a natural candidate there, and it closes on the timetable of an existing offering rather than a negotiated purchase. Our answer on DSTs for 1033 proceeds covers the reasoning and its limits.

After a casualty the similar-use test applies, and a passive trust interest may not resemble a building you operated yourself. Confirm that question with your CPA before you subscribe.

A few owners split the award: replace the operating property under the similar-use test and place the rest in traditional DST replacement where section 1033(g) allows it. See our DST like-kind qualification page for how the trust structure is tested.

Reporting and the open statute: how each election follows you

A 1031 exchange is reported on Form 8824 for the year you transfer the relinquished property. A 1033 deferral is elected, as Publication 544 puts it, on a statement attached to the return for the year you realize the gain, with the details of the conversion and the replacement.

Under section 1033(a)(2)(C) the assessment period for the gain stays open until three years after you notify the IRS of the replacement or of a decision not to replace. If the replacement is never made, the deferral is reversed for the year the gain was realized.

Basis follows similar logic in both statutes: under section 1033(b)(2), purchased replacement property takes its cost reduced by the gain not recognized, allocated by cost if you buy more than one property.