By Christina S. Porter

In a 5 to 4 decision, the Supreme Court in January of 2005 gave city governments the broad power to seize private property in order to generate tax revenue. That means property owners will have more limited rights when facing the threat of their property being condemned via eminent domain, which is defined as “the power of a government to take private property for public use, usually with compensation paid to the owner.”

The tax treatment of capital gains associated with a property that is appropriated by the government via eminent domain is a subject investment property owners ought to be aware of. Section 1033 of the IRS Procedural Code, also known as a 1033 rollover, addresses how an investor/business owner can defer payment of capital gain taxes when “involuntarily converting” investment/business property:

- Destruction of the property that is beyond the control of the taxpayer

- Theft of the property

- Seizure or requisition of property

- Taking of the property through condemnation or eminent domain

- Disposition of the property upon the threat or imminence of condemnation or eminent domain

The rule provides that a taxpayer must make a “valid” or “timely” election by not reporting a recognized gain on a tax return for the year that the conversion took place.

THE REPLACEMENT PROPERTY

The rules for choosing a replacement property set forth in a 1033 rollover are very specific. The kind of replacement property you can select is narrower than under a 1031 exchange. To further complicate matters, the types of replacement properties are a function of if you were an owner user or an owner investor. Make sure to tax to your tax advisor or real estate attorney before selecting your replacement property.

COMPARING SECTIONS 1033 AND 1031

There are certain instances when a property owner will have the choice to take advantage of either one of these sections. When considering which one to employ, please take note of the following:

Section 1031 provides a much larger amount of flexibility when it comes to choosing a replacement property (like kind).

Section 1033 allows two to three years to choose your replacement property — section 1031 gives 45 days to identify and 180 days to complete the sale. But be careful because this can get away from you.

Section 1033 does not require a qualified intermediary. You can take the proceeds of the sale as long as you reinvest them according to the rules within two to three years.

(You can reach Christina Porter at 1-877-4 TM 1031, or e-mail her at christina@tm1031exchange.com to discuss your specific needs. TM 1031 Exchange assists investors in planning and executing successful real estate investment strategies. Visit www.tm1031exchange.com for a complete list of investment properties and to download the TM 1031 Tool Kit.)