Over the weekend, someone posted a comment on an earlier piece involving the City of Vista’s Efforts to Assemble an Auto Mall.  The comment referred to potential tax advantages to owners facing condemnation, and was probably more timely than the person commenting realized.  Here is the main point of the comment:

I have read that Owners forced to sell property though eminent domain have tax advantages on any gain as opposed to if they sell voluntarily.

The comment refers to Internal Revenue Code Section 1033, which provides tax deferral for “involuntary conversions” of property.  Many people are familiar with so-called “1031 exchange” rules, which allow owners to transfer their basis from one investment property to another without triggering tax liability under certain circumstances.

Section 1033 is somewhat different, in that it applies where the owner “sells” involuntarily — for example, where the property is condemned.  Being an eminent domain attorney — not a tax attorney — I am not going to pretend to understand all of the niceties of how this works.  What I do know is that a “1033 conversion” offers advantages in many ways better than what owners performing a “1031 exchange” receive.  In particular:

  • The owner need not utilize an intermediary, but can actually hold the sale proceeds pending reinvestment; and
  • The reinvestment period is longer than the reinvestment time under section 1031.

That’s all well and good, but what makes this subject timely is that the California leglislature currently has before it Assembly Bill 2640 which would, if enacted, eliminate the state tax deferral for involuntary conversions.  Owners would still receive federal tax deferral (typically, deferral of the 15% federal capital gains tax), but would not avoid California tax on the gain (typically, around 10%).  The change would be retroactive to January 1, 2010.

One of my partners, Julia Caputo Stift has drafted a short summary of the measure entitled “Real Estate Owners May Lose Capital Gains Tax Shelter.”  We will keep you updated it if looks like this is getting close to passage.