Sequencing the § 1033 Election Around § 1245 Recapture

Section 1033 defers gain on the real property piece of a condemnation award — but only the real property piece, and only if the client acquires qualifying replacement property within the applicable replacement period. The planning challenge is sequencing: the client must decide how much of the award to deploy into replacement property before knowing exactly what their section 1245 cash liability will be at filing.

The Two-Step Framework

Step one: calculate the section 1245 recapture on the personal property components of the award. This number is fixed and non-deferrable. The client must retain sufficient cash to satisfy this liability.

Step two: calculate the remaining gain on the real property — the section 1250 unrecaptured gain and any additional section 1231 gain. This is the amount that can potentially be deferred under section 1033. The client's available reinvestment capital is the total award minus the section 1245 tax reserve.

Section 1250 Recapture — The Deferrable Piece

Section 1250 applies to depreciated real property — buildings, structural improvements, and other improvements to real estate that have been subject to depreciation. For commercial property held over time, the accumulated depreciation creates unrecaptured section 1250 gain, which is taxed at a maximum federal rate of 25% — separate from and in addition to any capital gain on appreciation above original cost.

Unlike section 1245 recapture, unrecaptured section 1250 gain may be deferred under section 1033 if the client makes a timely election and acquires qualifying replacement property within the replacement period. The gain is not eliminated — it carries forward into the basis of the replacement property — but deferral provides the client with the use of those funds in the interim.

Structuring the Section 1033 Election

The section 1033 election is made on the tax return for the year in which the gain is first recognized. The election defers recognition of gain to the extent that the proceeds are reinvested in qualifying replacement property. The replacement period for condemned real property under section 1033(g) is three years from the end of the first taxable year in which any gain is realized.

When Awards Cover Multiple Property Types

When a single condemnation involves both real property and personal property, the client's tax advisors will need to work through how the award is characterized for purposes of the section 1033 election. Our approach is consistent: less is best in the formal documents. Unless the litigation or settlement specifically requires a particular breakdown, keep the settlement clean and let the CPA and tax professionals work through the analysis on their end with maximum flexibility.

Pre-Closing Planning Sequence:

1. Identify section 1245 assets in the taking and calculate recapture on each.
2. Reserve cash for the section 1245 tax obligation — it is owed regardless of reinvestment.
3. Determine net proceeds available for reinvestment after the section 1245 reserve.
4. Calculate section 1250 unrecaptured gain — this is the deferrable piece.
5. Identify qualifying replacement property under section 1033(g).
6. Confirm the three-year replacement period for condemned business or investment real estate.
7. Make the section 1033 election on the timely filed return.

The Replacement Period and Advance Purchase

One significant advantage of section 1033 over section 1031 is the ability to acquire replacement property before the condemnation proceeds are received, provided the acquisition occurs after the threat of condemnation was first communicated. This advance purchase rule allows a client who identifies favorable replacement property early to lock it in without waiting for the closing.

The Bottom Line

The section 1033 election is not a magic eraser for the entire tax consequence of a condemnation. It is a deferral mechanism for the real property gain — one that requires planning, documentation, and timely execution. The section 1245 recapture sits outside the election entirely and must be planned for separately.

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This communication is provided for educational and informational purposes only and does not constitute legal, tax, accounting, or investment advice. The strategies discussed are general in nature and may not apply to specific individual circumstances. Any examples are hypothetical illustrations and are not a guarantee of any particular result. Tax laws are complex and subject to change; readers should consult qualified tax and legal professionals before acting on any strategy discussed.

Matt Chancey, Ross Brannon, Johnny Borrelli and Jacob Harvey are Registered Representatives of Crescent Securities Group, Inc. ("CSG"), Member FINRA/SIPC and an Investment Advisory Representative of Crescent Advisor Group, Inc. ("CAG"), an SEC Registered Investment Advisor. Neither CSG or CAG are affiliated with Tax Alpha Companies, Including Tax Alpha Title and Tax Alpha Solutions. Brokerage services offered through CSG. Investment advisory services offered through CAG. Steve Medendorp is a Florida licensed attorney but does not provide any legal or tax advice. Steve Medendorp and CSG or CAG are not affiliated.

This is not an offer to sell or a solicitation of an offer to buy any security that can only be sold by prospectus or confidential private placement memorandum. Strategies discussed are speculative, illiquid, and involve significant risk, such as potential loss of principal. All investments contain risk and cannot be guaranteed and you can lose some or all of your investment. Past performance is not indicative of future results. Prior to making any investment/financial decision you should consult your financial advisor and your accountant.