Catalin Clarke, CPA
Tax Supervisor

Large light rail projects have been implemented for quite some time in places such as New York, Chicago, and San Francisco and “by gum, it put them on the map!” But now, as the Puget Sound region grows, so does its perceived need of transportation infrastructure. Even when considering the limitations of today, a forward-looking eye can see the development of the future.

If you own a business or investment property within the path of light rail expansion, there is a good chance it could be converted at some point in the coming years. There is also a good chance that the appropriation of your property could trigger a taxable gain you might not have otherwise anticipated.

Fortunately, within Section 1033 of the Internal Revenue Code is a provision for such situations; the involuntary conversion. An involuntary conversion, or ‘1033 exchange’, is similar to a ‘1031/like-kind exchange,’ but more generous in some ways. Involuntary conversions can occur in various situations such as destruction, seizure, theft, requisition/condemnation, or threat thereof to property.

To be concise, a taxable gain occurs when the proceeds related to the sale of a property exceed the basis. Here is an example. Let’s say you bought a rental house 10 years ago, and it now occupies a potential expansion location. Your basis is most likely far less than what the forced purchase price will be. This means that your taxable gain could be substantial.

If you replace your requisitioned property with qualifying (similar or related in service or use) replacement property within the replacement period (generally 2 years, but certain situations can be longer), gain can be deferred by reducing the basis of your new property. This treatment is automatic if you are given qualified replacement property for what you gave up, however, you are far more likely to be given cash compensation in the current situation.

Important note: the gain is not eliminated, rather deferred. Further tax planning may be necessary to minimize exposure when the replacement property is sold or otherwise transferred.

As with many tax rules, there is far more substance to involuntary conversions than what can be summarized in a blog post. If you have questions or would like to explore your options in regards to U.S. Code Section 1033 - involuntary conversions, our tax advisors at The Doty Group will be happy to help!

Catalin Clarke, CPA is a Tax Supervisor at The Doty Group, focusing on taxation in hospitality, professional services, and closely-held Business. He holds a Bachelor of Science from the University of Washington, Tacoma.