What is a 1033 Exchange, Rules, and How it Compares to a 1031 Exchange

Wally Smith:
1033s, you run across many of those?

Jeff Hertz:
It depends on a couple things. Unfortunately with some of the wildfires out west in recent years, we’ve seen more just mentions of 1033 exchanges.

Wally Smith:
And let’s recap 1033.

Jeff Hertz:
Most people use the term a forced conversion, meaning your ownership of a property was taken away from you. And there’s really I’d say two main ways that we see that. One would be destruction of a property, floods, fires, those types of things. Second would be eminent domain. And that’s obviously much more common in, well, I actually came across it a lot in the Midwest because they were widening highways and things like that. And so the inconvenience of a farmer losing 10 acres, it changed the landscape of their assets. And so the government compensated them by paying them in a 1033 exchange. Couple of things that I think are very different about 1033 exchanges. Number one is the timing.
You typically have at least two years and sometimes even longer if the property was in a federally declared disaster area. So unlike a 1031 exchange where you have the 45 days and the 180 days and everything has to move very quickly, in a 1033 exchange, you generally have a lot more time on your hands. And of course, the other difference is the investor is going to take receipt of the funds themselves, and will basically just have the money in their bank account or wherever it’s going to be.

Wally Smith:
So that’s really important. They have a good CPA that understands it, but they don’t have to use a qualified intermediary. With the 1031, you do.

Jeff Hertz:
Correct. Exactly. And then there are some slightly more strict components of the 1033 exchange. The language is not like kind, but it’s similar in use or I can’t think of the exact words, but to be honest I’ve never seen a situation where the IRS challenged what investments the client went into. But yeah, similar in use.

Wally Smith:
You get out of a warehouse, maybe you need to keep it industrial, not be able to go from a warehouse that burnt down or was condemned into water rights or something far removed.

Jeff Hertz:
I was contacted about a case last week where the client still retained the land that the building was on, and they still had that land that had some value to it. The only thing they were getting compensated for was the destruction of the property itself. That’s quite a bit different than a typical 1031 exchange where you’re selling everything, the land and the building.

Wally Smith:
And there are also rules, with the 1033, I believe you just have to put the gain in that you’re able to actually retain the basis if you want to. So that’s unusual.

Jeff Hertz:
You also can use debt to offset the value of the property. So people tend to like higher leveraged assets because they can replace the value of the property.

Wally Smith:
Very good.

Jeff Hertz:
You don’t have to bifurcate the equity in debt the way you do in a 1031.