I.R.C. Section 1033 Replacement Periods
Section 1033 of the Internal Revenue Code of 1954 provides for the nonrecognition of gain when property is compulsorily or involuntarily converted. Section 1033(a) requires that such conversions occur "as a result of destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof." If an involuntary conversion results in a gain, the gain need not be recognized if the proceeds are invested in similar property of equal or greater value within a specified period.
Important in determining a property owner’s replacement period are several criteria, including the type of property and its use at the time of conversion, as well as the kind of property to be acquired. In addition, the manner of conversion (e.g., eminent domain vs. destruction) will dictate the time allowed for replacement.
Regarding involuntary conversions by eminent domain, the start of the replacement period is triggered by the earlier of three dates:
a. Date the property was condemned or seized;
b. Date the property was first subjected to threat or imminence of condemnation or seizure; or
c. Date the property was sold or exchanged under threat or imminence of condemnation or seizure.
The replacement period for conversions arising from theft or destruction (usually compensable through insurance payouts) begins on the date the incident occurred. Destruction of property, for purposes of §1033, is analogous to casualty under §165 as an involuntary conversion of property arising from fire, storm, shipwreck, or other casualty.
Pursuant to §1033(a)(2)(B), the replacement period ends two years after the close of the first taxable year in which any part of the gain upon the conversion is realized. For example, compensation received any time in 2017 must be invested into similar property by December 31 of 2019 to qualify for tax deferral. Although difficult to obtain, the replacement period may be extended with permission from the IRS.
Special rules apply to investment real estate converted by seizure, requisition or condemnation (or threat or imminence), but not by theft or destruction. §1033(g)(4) expands to three years the replacement period for property held for productive use in trade or business, or for investment.
The replacement period for personal residences destroyed by a Federally declared disaster is extended to 4 years.