An involuntary conversion example through eminent domain that surprises most owners: the replacement property can be bought before the condemnation closes, before the award is paid, and before the owner knows the final number, and the purchase still counts. Section 1033 dates the replacement window from the earliest date of the threat or imminence of condemnation, not from the taking. That gives an owner who has been looking for the right property anyway a good deal of room. The example is a condemnation, not a casualty loss; the threat rule discussed here has no counterpart for property lost to fire or storm.
The short version. Once the agency has made a real threat to take the property, the owner can buy the replacement. The purchase does not have to wait for the award, but it does have to come after the threat.
The involuntary conversion example, step by step
A trucking company owns a terminal on a highway frontage. In March the state transportation department sends a letter stating that the parcel is in the path of an interchange and that the state will acquire it by negotiation or condemnation. The company has been looking for a larger site for two years and finds one in November. It closes on the new site in December with bank financing. The state files the condemnation the following June, and the award is paid in September.
The December purchase qualifies as replacement property. The threat letter in March started the period. The purchase came after the threat and inside the window. When the award arrives, the company elects under Section 1033, the gain is deferred to the extent the cost of the new site covers the amount realized, and the loan is paid down from the award without affecting the election.
Why the statute allows it
Section 1033(a)(2)(B) defines the period as beginning on the date of the disposition of the converted property, or the earliest date of the threat or imminence of requisition or condemnation, whichever is earlier, and ending two or three years after the close of the first taxable year in which any part of the gain is realized. The window opens at the threat. Anything bought inside the window, before or after the taking, is a candidate for replacement property if it otherwise qualifies.
What counts as a threat of condemnation under section 1033
The threat has to be real. The Tax Court’s decision in Johnson v. Commissioner laid out the test: the body making the threat has eminent domain authority, an authorized official told the owner the property would be taken if not sold, and the owner reasonably believed it. A written notice from the condemning authority, a published project map that names the parcel, or an appraiser sent by the agency usually meets it. A rumor, a newspaper article, or a planning document that does not identify the parcel usually does not. The article on involuntary conversion under threat of condemnation covers the cases.
What does not count: property bought before the threat
Property acquired before the earliest date of the threat is outside the window and does not qualify, no matter how clearly the owner saw the project coming. The owner in the example who closed on the new terminal the February before the March letter would have no replacement property, because the window had not opened. The purchase has to come after the first documented threat, and the documentation of that threat belongs in the close-out file.
Practitioner note. When a client reports that the agency has been in contact, get the date and the form of the contact into the file the same week. The earliest documented threat is the opening of the window, and it is also the date the IRS will test a pre-taking purchase against. A letter from the agency is the cleanest proof. If the first contact was a phone call, a dated note of who called and what was said will serve.
Paying for it before the award arrives
Section 1033 does not trace money. The election compares the amount realized on the conversion with the cost of the replacement property acquired inside the window. It does not ask whether the award dollars were the dollars used. An owner can buy the replacement with a bank loan, with cash on hand, or with proceeds from another sale, and then apply the award to the loan or to anything else. The 1033 exchange rules on this point are more forgiving than Section 1031, which requires the proceeds to pass through an intermediary.
The one thing to watch is the amount. Deferral is limited to the extent the cost of the replacement covers the amount realized. If the award comes in higher than the price of the property already bought, the excess is recognized unless more qualifying property is acquired inside the window.
Where a tax specialist fits
We are not the owner’s attorney and we do not negotiate awards. What we do is date the window from the first threat, confirm that a purchase the owner wants to make will qualify, and size it against the likely award before the owner signs. 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
Can you buy replacement property before condemnation closes?
Yes. The replacement period begins at the earliest date of the threat or imminence of condemnation. Property bought after that date and before the period ends qualifies, even if the award has not been paid.
What is the threat of condemnation 1033 rule?
A sale made under a threat or imminence of condemnation is treated as an involuntary conversion, and the threat date opens the replacement window. The threat has to come from a body with eminent domain authority and be one the owner reasonably believes.
Do you have to use the award money itself to buy the replacement?
No. Section 1033 compares the amount realized with the cost of the replacement property; it does not trace the funds. The owner can borrow to buy, then use the award to repay the loan.
Has an agency put your client’s parcel on a project map, and is there a property the client wants to buy now? A free thirty-minute call with Steve Medendorp confirms the window is open before the contract is signed.
