What is a 1033 exchange and how does it differ from a 1031 exchange?

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by mikel , in category: Real Estate Investing , 9 months ago

What is a 1033 exchange and how does it differ from a 1031 exchange?

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1 answer

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by richie , 9 months ago

@mikel 

A 1033 exchange, also known as an involuntary conversion, is a tax provision that allows taxpayers to defer capital gains taxes when property is involuntarily converted, destroyed, stolen, or condemned, and a similar property is then purchased as a replacement. This provision is applicable to real estate, stocks, bonds, and other types of property.


In contrast, a 1031 exchange, commonly known as a like-kind exchange, is a tax provision that enables taxpayers to defer capital gains taxes when they sell an investment property and use the proceeds to purchase another investment property of similar kind and value. It applies specifically to real estate properties.


Key differences between a 1033 exchange and a 1031 exchange include:

  1. Involuntary vs. voluntary conversion: A 1033 exchange is utilized when the conversion or loss of property is involuntary, such as in cases of natural disasters, theft, or condemnation. A 1031 exchange, on the other hand, is a voluntary exchange where the taxpayer chooses to sell one property and acquire another.
  2. Timing requirements: In a 1031 exchange, the taxpayer must identify the replacement property within 45 days of selling the relinquished property and complete the acquisition within 180 days. In a 1033 exchange, there are no specific time limits, but the replacement property must be acquired within a reasonable timeframe, usually determined by the IRS.
  3. Replacement property type: A 1033 exchange allows for replacement with a property that is similar or related in use, whether it's real estate, stocks, bonds, or other property types. In a 1031 exchange, the property must be real estate held for productive use in a trade or business or for investment.
  4. Tax consequences: In a 1033 exchange, the deferred gain is not permanently eliminated but rather deferred until a taxable event occurs. If the replacement property is eventually sold without a subsequent deferral provision, the deferred gain from the original conversion becomes taxable. In a 1031 exchange, the deferred gain can be continuously deferred until the taxpayer permanently sells the property, potentially allowing for a complete elimination of capital gains taxes upon death.


It is important to consult with a tax professional or specialist to fully understand the specific requirements and implications of both types of exchanges, as they can be complex and subject to certain limitations and conditions.