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Section 1033: A "Kissing Cousin" to Section 1031
 A 1031 exchange is an excellent tool to use to defer taxes indefinitely that might otherwise be due on the sale of investment property. Similarly, there is also tax relief available to investors when their property is acquired by a governmental authority or destroyed. The rules governing these events are covered under Section 1033 of the Internal Revenue Code. Both Section 1031 and Section 1033 allow gain and the related tax to be rolled forward into like-kind replacement property as long as the taxpayer complies with certain provisions. The technical tax and legal term used to describe both destruction of property and property taken by the government is "involuntary conversion". When a governmental authority takes property from an owner, it does so by the powers of eminent domain, which is essentially a compulsory purchase or condemnation. While there are similarities in the rules of Sections 1031 and 1033, there are many differences; lesser differences also can be found between property taken by eminent domain and property that is destroyed.
Property taken by eminent domain is the most common. This term defines situations in which a government authority exercises its right to take property that it wants to use from the owner, whether or not the owner wishes to sell. The most common uses of property taken by eminent domain are for government buildings and other facilities, public utilities, highways, and railroads. In what may be better described as a "forced purchase", the governing authority must first compensate the owner for the fair market value of the property. Despite the terminology, in practice, this is usually a friendly transaction that begins when the government authority contacts the owner of the property letting them know their interest in purchasing it. The next step is for appraisals to be done and moves forward when both the owner and the authority agree on a price. (If they can't agree on price, the owner does have the right to appeal to a court of law to determine the fair market value.)
An owner who sells a property to a governing authority in this way may be facing a taxable gain that they would like to defer. In an "eminent domain" Section 1033, the "like-kind" definition of the replacement property is the same as the definition under Section 1031: "property held for productive use in a trade or business or for investment." Also similarly, the property acquired must be the same price or greater than the property that was taken. But unlike Section 1031, there is no requirement to replace the cash proceeds and the debt that may have been relieved in the sale.
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