1031 vs 1033 Exchange Tax Deferral Strategy
When property owners sell or lose a property, they often look for ways to defer capital gains taxes. Two key IRS provisions—Section 1031 and Section 1033 — offer opportunities to defer taxes under specific conditions. While both allow for the deferral of gain, they apply to very different situations and have distinct requirements.
This article explains how 1031 and 1033 Exchanges work, their differences, and when each may apply.
What Is a 1031 Exchange?
A 1031 Exchange (under Section 1031 of the Internal Revenue Code) allows investors to defer capital gains taxes when selling one investment or business property and reinvesting the proceeds into another like-kind property.
Key Points:
Eligible property: Real property held for investment or business use.
Like-kind requirement: Both the relinquished and replacement properties must be real estate of like kind.
Time limits: Investors must identify a replacement property within 45 days and complete the exchange within 180 days of the sale.
Qualified Intermediary (QI): Funds from the sale must be held by a QI to preserve tax deferral.
A 1031 Exchange is voluntary—it’s used strategically by investors to grow or consolidate their real estate portfolios while deferring taxes.
What Is a 1033 Exchange?
A 1033 Exchange (under Section 1033 of the Internal Revenue Code) applies when property is involuntarily converted—for example, through condemnation, eminent domain, or destruction (such as fire or natural disaster).
Key Points:
Involuntary conversion: The exchange occurs because the owner is forced to give up the property, not by choice.
Replacement property: The owner must reinvest the proceeds (such as insurance or condemnation payments) into similar or related property.
Flexible timeline: Taxpayers typically have two to three years—and in some cases up to four years—to acquire replacement property, depending on the situation.
No Qualified Intermediary required: Since proceeds are received involuntarily, the owner can hold the funds directly without disqualifying the deferral.
A 1033 Exchange is reactive—it helps taxpayers recover financially from a loss or government action while deferring tax liability.
Key Differences Between 1031 and 1033 Exchanges
Feature 1031 Exchange 1033 Exchange Type of transaction Voluntary sale Involuntary conversion (condemnation, destruction, etc.) Property type Real property held for investment or business Property (real or personal) lost involuntarily Like-kind requirement Must be like-kind real estate Must be similar or related in service or use Timeline 45 days to identify, 180 days to close Typically 2–3 years to reinvest Use of Qualified Intermediary Required Not required Control of proceeds Cannot touch sale proceeds Can receive and hold funds directly IRS Section Section 1031 Section 1033
Example Scenarios
1031 Exchange Example:
An investor sells a commercial building and uses a Qualified Intermediary to reinvest the proceeds into an apartment complex within 180 days. The transaction qualifies for tax deferral under Section 1031.
1033 Exchange Example:
A property owner’s land is taken by the government under eminent domain. The owner receives compensation and reinvests it into another piece of similar property within three years. The gain from the condemnation is deferred under Section 1033.
Choosing the Right Strategy
While both exchanges offer tax-deferral benefits, the context determines which one applies:
If you choose to sell and reinvest, Section 1031 is your path.
If your property is lost involuntarily, Section 1033 provides relief.
Because timelines, requirements, and replacement rules differ significantly, consulting a tax professional or Qualified Intermediary is critical before taking action.
Both 1031 and 1033 Exchanges are powerful tools for deferring capital gains taxes—but they apply in different circumstances. Understanding which section fits your situation can help you preserve your investment capital and stay compliant with IRS regulations.
Disclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Investors should consult with their CPA, attorney, or Qualified Intermediary before initiating an exchange.
