[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1033(a)-2]

[Page 121-124]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1033(a)-2  Involuntary conversion into similiar property, into 
money or into dissimilar property.

    (a) In general. The term disposition of the converted property means 
the destruction, theft, seizure, requisition, or condemnation of the 
converted property, or the sale or exchange of such property under 
threat or imminence of requisition or condemnation.

[[Page 122]]

    (b) Conversion into similar property. If property (as a result of 
its destruction in whole or in part, theft, seizure, or requisition or 
condemnation or threat or imminence thereof) is compulsorily or 
involuntarily converted only into property similar or related in service 
or use to the property so converted, no gain shall be recognized. Such 
nonrecognition of gain is mandatory.
    (c) Conversion into money or into dissimilar property. (1) If 
property (as a result of its destruction in whole or in part, theft, 
seizure, or requisition or condemnation or threat or imminence thereof) 
is compulsorily or involuntarily converted into money or into property 
not similar or related in service or use to the converted property, the 
gain, if any, shall be recognized, at the election of the taxpayer, only 
to the extent that the amount realized upon such conversion exceeds the 
cost of other property purchased by the taxpayer which is similar or 
related in service or use to the property so converted, or the cost of 
stock of a corporation owning such other property which is purchased by 
the taxpayer in the acquisition of control of such corporation, if the 
taxpayer purchased such other property, or such stock, for the purpose 
of replacing the property so converted and during the period specified 
in subparagraph (3) of this paragraph. For the purposes of section 1033, 
the term control means the ownership of stock possessing at least 80 
percent of the total combined voting power of all classes of stock 
entitled to vote and at least 80 percent of the total number of shares 
of all other classes of stock of the corporation.
    (2) All of the details in connection with an involuntary conversion 
of property at a gain (including those relating to the replacement of 
the converted property, or a decision not to replace, or the expiration 
of the period for replacement) shall be reported in the return for the 
taxable year or years in which any of such gain is realized. An election 
to have such gain recognized only to the extent provided in subparagraph 
(1) of this paragraph shall be made by including such gain in gross 
income for such year or years only to such extent. If, at the time of 
filing such a return, the period within which the converted property 
must be replaced has expired, or if such an election is not desired, the 
gain should be included in gross income for such year or years in the 
regular manner. A failure to so include such gain in gross income in the 
regular manner shall be deemed to be an election by the taxpayer to have 
such gain recognized only to the extent provided in subparagraph (1) of 
this paragraph even though the details in connection with the conversion 
are not reported in such return. If, after having made an election under 
section 1033(a)(2), the converted property is not replaced within the 
required period of time, or replacement is made at a cost lower than was 
anticipated at the time of the election, or a decision is made not to 
replace, the tax liability for the year or years for which the election 
was made shall be recomputed. Such recomputation should be in the form 
of an amended return. If a decision is made to make an election under 
section 1033(a)(2) after the filing of the return and the payment of the 
tax for the year or years in which any of the gain on an involuntary 
conversion is realized and before the expiration of the period within 
which the converted property must be replaced, a claim for credit or 
refund for such year or years should be filed. If the replacement of the 
converted property occurs in a year or years in which none of the gain 
on the conversion is realized, all of the details in connection with 
such replacement shall be reported in the return for such year or years.
    (3) The period referred to in subparagraphs (1) and (2) of this 
paragraph is the period of time commencing with the date of the 
disposition of the converted property, or the date of the beginning of 
the threat or imminence of requisition or condemnation of the converted 
property, whichever is earlier, and ending 2 years (or, in the case of a 
disposition occurring before December 31, 1969, 1 year) after the close 
of the first taxable year in which any part of the gain upon the 
conversion is realized, or at the close of such later date as may be 
designated pursuant to an application of the taxpayer. Such application 
shall be made prior to the expiration of 2 years (or, in the case of

[[Page 123]]

a disposition occurring before December 31, 1969, 1 year) after the 
close of the first taxable year in which any part of the gain from the 
conversion is realized, unless the taxpayer can show to the satisfaction 
of the district director--
    (i) Reasonable cause for not having filed the application within the 
required period of time, and
    (ii) The filing of such application was made within a reasonable 
time after the expiration of the required period of time. The 
application shall contain all of the details in connection with the 
involuntary conversion. Such application shall be made to the district 
director for the internal revenue district in which the return is filed 
for the first taxable year in which any of the gain from the involuntary 
conversion is realized. No extension of time shall be granted pursuant 
to such application unless the taxpayer can show reasonable cause for 
not being able to replace the converted property within the required 
period of time.

See section 1033(g)(4) and Sec. 1.1033(g)-1 for the circumstances under 
which, in the case of the conversion of real property held either for 
productive use in trade or business or for investment, the 2-year period 
referred to in this paragraph (c)(3) shall be extended to 3 years.
    (4) Property or stock purchased before the disposition of the 
converted property shall be considered to have been purchased for the 
purpose of replacing the converted property only if such property or 
stock is held by the taxpayer on the date of the disposition of the 
converted property. Property or stock shall be considered to have been 
purchased only if, but for the provisions of section 1033(b), the 
unadjusted basis of such property or stock would be its cost to the 
taxpayer within the meaning of section 1012. If the taxpayers unadjusted 
basis of the replacement property would be determined, in the absence of 
section 1033(b), under any of the exceptions referred to in section 
1012, the unadjusted basis of the property would not be its cost within 
the meaning of section 1012. For example, if property similar or related 
in service or use to the converted property is acquired by gift and its 
basis is determined under section 1015, such property will not qualify 
as a replacement for the converted property.
    (5) If a taxpayer makes an election under section 1033(a)(2), any 
deficiency, for any taxable year in which any part of the gain upon the 
conversion is realized, which is attributable to such gain may be 
assessed at any time before the expiration of three years from the date 
the district director with whom the return for such year has been filed 
is notified by the taxpayer of the replacement of the converted property 
or of an intention not to replace, or of a failure to replace, within 
the required period, notwithstanding the provisions of section 6212(c) 
or the provisions of any other law or rule of law which would otherwise 
prevent such assessment. If replacement has been made, such notification 
shall contain all of the details in connection with such replacement. 
Such notification should be made in the return for the taxable year or 
years in which the replacement occurs, or the intention not to replace 
is formed, or the period for replacement expires, if this return is 
filed with such district director. If this return is not filed with such 
district director, then such notification shall be made to such district 
director at the time of filing this return. If the taxpayer so desires, 
he may, in either event, also notify such district director before the 
filing of such return.
    (6) If a taxpayer makes an election under section 1033(a)(2) and the 
replacement property or stock was purchased before the beginning of the 
last taxable year in which any part of the gain upon the conversion is 
realized, any deficiency, for any taxable year ending before such last 
taxable year, which is attributable to such election may be assessed at 
any time before the expiration of the period within which a deficiency 
for such last taxable year may be assessed, notwithstanding the 
provisions of section 6212(c) or 6501 or the provisions of any law or 
rule of law which would otherwise prevent such assessment.
    (7) If the taxpayer makes an election under section 1033(a)(2), the 
gain upon the conversion shall be recognized to the extent that the 
amount realized upon such conversion exceeds the cost

[[Page 124]]

of the replacement property or stock, regardless of whether such amount 
is realized in one or more taxable years.
    (8) The proceeds of a use and occupancy insurance contract, which by 
its terms insured against actual loss sustained of net profits in the 
business, are not proceeds of an involuntary conversion but are income 
in the same manner that the profits for which they are substituted would 
have been.
    (9) There is no investment in property similar in character and 
devoted to a similar use if--
    (i) The proceeds of unimproved real estate, taken upon condemnation 
proceedings, are invested in improved real estate.
    (ii) The proceeds of conversion of real property are applied in 
reduction of indebtedness previously incurred in the purchase or a 
leasehold.
    (iii) The owner of a requisitioned tug uses the proceeds to buy 
barges.
    (10) If, in a condemnation proceeding, the Government retains out of 
the award sufficient funds to satisfy special assessments levied against 
the remaining portion of the plot or parcel of real estate affected for 
benefits accruing in connection with the condemnation, the amount so 
retained shall be deducted from the gross award in determining the 
amount of the net award.
    (11) If, in a condemnation proceeding, the Government retains out of 
the award sufficient funds to satisfy liens (other than liens due to 
special assessments levied against the remaining portion of the plot or 
parcel of real estate affected for benefits accruing in connection with 
the condemnation) and mortgages against the property, and itself pays 
the same, the amount so retained shall not be deducted from the gross 
award in determining the amount of the net award. If, in a condemnation 
proceeding, the Government makes an award to a mortgagee to satisfy a 
mortgage on the condemned property, the amount of such award shall be 
considered as a part of the amount realized upon the conversion 
regardless of whether or not the taxpayer was personally liable for the 
mortgage debt. Thus, if a taxpayer has acquired property worth $100,000 
subject to a $50,000 mortgage (regardless of whether or not he was 
personally liable for the mortgage debt) and, in a condemnation 
proceeding, the Government awards the taxpayer $60,000 and awards the 
mortgagee $50,000 in satisfaction of the mortgage, the entire $110,000 
is considered to be the amount realized by the taxpayer.
    (12) An amount expended for replacement of an asset, in excess of 
the recovery for loss, represents a capital expenditure and is not a 
deductible loss for income tax purposes.

(Secs. 1033 (90 Stat. 1920, 26 U.S.C. 1033), and 7805 (68A Stat. 917, 26 
U.S.C. 7805)

[T.D. 6500, 25 FR 11910, Nov. 26, 1960, as amended by T.D. 6679, 28 FR 
10515, Oct. 1, 1963; T.D. 7075, 35 FR 17996, Nov. 24, 1970; T.D. 7625, 
44 FR 31013, May 30, 1979; T.D. 7758, 46 FR 6925, Jan. 22, 1981]