A 1033 exchange due to Fire of a 1031 Exchanged Property.
Investor · Daytona/Ormond Beach Fl, Charleston/Summerville SC · Member since 2017 · 156 posts · 73 votes
I have/had a SFR in SC, which was an exchange property in a CA 1031. We had a severe fire with an estimated 6 to 9 months to rebuild.
We opted to use the insurance payoff to payoff the mortgage (BTW this is much more complex than you might imagine) and sell the home AS IS to a Flipper. I can do a 1031 on the Flip sale (then the tax reporting seems difficult) but the 1033 exchange rules seem like the more flexible way to go. However I have not found any written rules like in the case of the 1031 exchange.
That is:
1) Does the new property have to be >= t the net sale of the Flip Sale plus Insurance like a 1031?
2) Does the new mortgage have to be >= the old mortgage like a 1031?
3) I understand there is no requirement for a QI to handle funds.
4) I understand the time lines are more relaxed and 2 years in mentioned but no real rule.
5) I see talk about identifying the exchange property on a tax return but again no rule or how to do this.
I would appreciate any help on this issue and thanks for @Dave Foster for heads up to the 1033 in the first place.
Cheers,
Buddy
Well I have leaned a little more about 1033 Exchanges and would like to pass along to the BP group.
I have found the IRS 1033 (a)(2)(A) form to send with your tax return. At least I have found the Turbo Tax form to do this.
It does not have an official IRS form number so ... Anyway the first tax report filing after your fire loss you fill out this form and tell the IRS the details what and when it all happened and how much you received in insurance and sale of the remains.
You also list how much the property cost and when you bought it. If it was a 1031 property to start, you provide the basis which includes the original 1031 reduction as well as the normal allowed year to year reduction claimed on your tax returns since renting it. If you have not yet replaced the property, you state on this form that you are reporting a delayed 1033 Exchange and describe your intent to replace it with a "like kind" property within 2 years.
"Like kind" is a bit more restrictive than the 1031 rules as I understand for rental property it is residential for residential and commercial for commercial and the two can not be mixed. I assume SFR to Multi family residential is OK.
As I understand the 2 year period, it starts with the first tax return notification. So a fire in 2020 starts in 2021 and the replacement must be reported by the 2023 tax return. I don't plan to test that definition too much and plan to replace by two year from the Fire loss just to be sure.
There is no call for a QI which is good because insurance payments and mortgage payments alone is sufficient nightmare.
There doesn't seem to be any requirement for mortgage matching like the 1031.
The only issue is the Replacement property must be same or greater than the loss property gross cash obtained.
As a side, in such cases insurance checks are written to the insured AND the mortgage holder. Unless the insurance is sufficient to pay off the mortgage or even if it is, don't expect to be able to sell the remains very quickly.
Mortgage companies are set up for conventional closing where they get all their money from the escrow or lawyer'c closing.
If people pay off their mortgage with out selling, the system eventually produces a letter to be recorded at your county deed office that the deed to secure debt has been satisfied. The mortgage company can't you or your lawyer a simple note that the mortgage has been paid. Totally unthinkable that anyone should nee this to sell the remains of the home!
For checks coming in from insurance companies they expect to hold the check and payoff small amounts to a contractor as the home is refurbished. These three processes are totally different departments and there is no hope in changing the systems!
So I hope y'all never need to do a 1033 but should you have the misfortune to need to, it seems like a nice silver lining tax law. Again Thanks to @Dave Foster for pointing this out to me.
As a follow up, I can add...
I made the 2020 tax return as discussed above and indicated that the exchange property had not been selected yet.
I had been looking for a DST investment but could not find one with the needed l/V of ~75% which I needed to make the 1033 exchange requirements with the cash available for the Insurance and sale proceeds. Since then I found an LLP group buying an Apartment Complex in Greenville, SC than had the necessary L/V. They were not as familiar with the 1031 process as the DST sponsors, but I finally got the financial details I need to document the exchange. This will be done in the 2021 Tax return.