In a 1033 involuntary conversion from condemnation, the replacement clock starts at the close of the first taxable year in which any part of the gain is realized. That is a tax event, not a legal one. Everything in this article is about a condemnation or a sale under threat of condemnation; a casualty loss paid by insurance is also an involuntary conversion, but its timing questions are different and are not covered here. It is not the date the agency took possession, not the date the condemnation was filed, and not the date the final award was entered. For an owner paid in full at the taking, the distinction does not matter. For an owner whose award arrives in pieces over two or three years, it may mean the deadline has not started at all.
The short version. The clock runs from the end of the year you first had gain, meaning the year the money received passed the property’s basis. A deposit smaller than basis does not start it. Nothing stops it once it starts except an extension from the IRS.
When the 1033 involuntary conversion clock starts: the year gain is first realized
Section 1033(a)(2)(B) counts the period from the close of the first taxable year in which any part of the gain upon the conversion is realized. Gain is realized when the amount received exceeds the adjusted basis of the property converted. If the condemning authority pays the whole award in the year of the taking, and the award exceeds basis, the gain is realized that year and the period starts at the end of it. That is the common case.
The deposit that does not start the clock
In a quick-take, the authority deposits its estimate of value with the court and takes possession. The owner may withdraw the deposit. If the deposit is less than the property’s adjusted basis, no gain has been realized, and the clock has not started. It starts at the end of the first year in which the deposit plus later payments exceed basis. For a long-held property with low basis the deposit almost always exceeds basis and the clock starts at once; for a recently purchased property with high basis, the clock may not start until the final award is paid years later. Either way the owner needs the basis number before the deposit is withdrawn, which is a question for the CPA and the close-out file.
Practitioner note. Treat the first year any money exceeds basis as the clock year, and write it in the file. The election is made on the return for that year. If the owner is unsure whether the deposit exceeded basis, the safe course is to assume it did and to file the election statement on that year’s return; an election made a year early does no harm, and one made a year late can cost the deferral. The section 1033 involuntary conversion election is described on For Advisors page.
Interest and the clock
Interest paid on the award for the delay between the taking and payment is not part of the amount realized on the conversion. It is ordinary income in the year received, and it neither counts toward gain on the property nor starts the replacement clock. An owner who receives only interest in a year has no conversion gain in that year. The article on interest on a condemnation award covers the tax treatment of that piece.
Severance damages and the clock
Severance damages paid for the harm to the part of the property that was not taken reduce the basis of the retained parcel first. They produce gain only to the extent they exceed that basis, and that gain, when it occurs, is realized in the year the severance payment exceeds the retained basis. It runs on the same replacement clock as the gain on the parcel taken, and under Rev. Rul. 83-49 it can be deferred by reinvestment in qualifying property. The articles on severance damages and the allocation and on replacement property under Rev. Rul. 83-49 go deeper.
Nothing stops the clock except an IRS extension
An appeal of the award does not stop the clock. A dispute with the agency over the deposit does not stop it. A buyer backing out of the replacement purchase does not stop it. Once gain has been realized, the period runs to its end unless the owner applies to the IRS and receives an extension for reasonable cause, which the companion article on the involuntary conversion replacement period explains. What litigation can do is keep the clock from starting, by keeping total payments below basis until the final award. Whether that happens is a question of fact in each file.
Basis in replacement property after condemnation
When the election is made and the gain is deferred, the basis in the replacement property is its cost reduced by the gain that was not recognized, under Section 1033(b). The deferral is a postponement, not a forgiveness: the gain reappears when the replacement property is later sold, through the lower basis. If the replacement is depreciable, the lower basis also means lower depreciation. Owners who treat the deferred gain as gone tend to be surprised at the next sale.
Where a tax specialist fits
We are not the owner’s attorney and we do not negotiate awards. What we do is identify the clock year from the basis and the payment schedule before the deposit is withdrawn, and keep the election and the replacement deadline together in one place. We work alongside the owner’s attorney and CPA, not instead of them. If the owner does not need us, we say so. The first call is free.
Frequently asked questions
When does the replacement period start in a 1033 involuntary conversion?
At the close of the first taxable year in which any part of the gain is realized, which is the first year the payments received exceed the adjusted basis of the property converted. It does not start on the date of the taking.
Does a quick-take deposit start the section 1033 involuntary conversion clock?
Only if the deposit exceeds the property’s adjusted basis. If it does not, no gain has been realized and the clock waits until the first year that later payments push the total over basis.
What is the basis in replacement property after condemnation?
The cost of the replacement property minus the gain that was deferred under the Section 1033 election. The deferred gain comes back as lower basis, which means more gain on a later sale and less depreciation if the property is depreciable.
Did your client withdraw a deposit this year and nobody has said what the basis is? A free thirty-minute call with Steve Medendorp finds the clock year before the return is filed.
