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1033 Exchange Issues: Replacement Property Period For Involuntary Conversions

Where property is destroyed (in whole or in part) or stolen, or condemned, the replacement period for purchasing similar-or-related-in-use property for purposes of the nonrecognition rule  begins on the date of the converted property's disposition, or the earliest date of the threat or imminence of condemnation. It ends two years after the close of the first tax year the taxpayer realizes any part of the gain on the involuntary conversion, unless extended (see below).

If the taxpayer's principal residence or any of its contents is involuntarily converted as a result of a Presidentially-declared disaster, substitute four years for the two years above.

For property in the Hurricane Katrina disaster area that is compulsorily or involuntarily converted after Aug. 24, 2005 by reason of Hurricane Katrina, and substantially all of the use of the replacement property is in the Hurricane Katrina disaster area, substitute five years for the two years above.

Similarly, if taxpayer's property that is compulsorily or involuntarily converted as a result of the terrorist attacks on Sept. 11, 2001, in the “New York Liberty Zone”, and substantially all of the use of the replacement property is in New York City, substitute five years for the two years above.

If real property (not stock in trade or other property held primarily for sale), held for productive use in trade or business or for investment, is condemned or requisitioned by the government, or if condemnation is threatened or is imminent, the replacement period ends three years after the close of the first tax year the taxpayer realizes any part of the gain on the involuntary conversion, unless extended (see below).

Illustration:     

 

City notifies D officially on Mar. 1, Year 1, that the city intends to acquire D's real property by negotiation or, if he refuses, by condemnation. The city acquired title on Sept. 7, when D's basis in the property was $40,000. On Dec. 1, the city paid D $35,000; in Jan. of Year 2, it paid him another $10,000; and in Mar. of Year 3 the city made a final payment of $20,000. The replacement period began on Mar. 1, Year 1, when the city notified D of the city's intention to condemn, and ended on Dec. 31, Year 5, three years after the close of the first year in which gain was realized (Year 2, when payments first exceeded D's basis).

 

An extension of the replacement period may be granted if taxpayer applies to the district director for the district where the tax return containing the nonrecognition-of-gain election was filed. The application should be filed before the expiration of the regular replacement period, but may be made later if the taxpayer can show: (a) reasonable cause for not having filed the application within the required period, and (b) the filing was made within a reasonable time thereafter.

Extensions ordinarily won't be granted for more than one year. The extension will be granted if the replacement property is being constructed, and taxpayer can show construction won't be completed within the statutory period.

 

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