## Facts

- A taxpayer corporation engaged in the banking business owned an office building that it leased to tenants for rental income.
- A tornado destroyed the office building, resulting in an involuntary conversion.
- The taxpayer received insurance proceeds from the destruction.
- The taxpayer used the proceeds to construct a new office building.
- The taxpayer used part of the new building to conduct its banking business and leased the remainder to tenants.
- The leases for the new building were similar to the leases for tenants in the destroyed building.

## Issues

1. Whether the taxpayer’s construction of a new office building, used partly for its banking operations and partly for leasing to tenants on similar lease terms, constitutes replacement property “similar or related in service or use” under I.R.C. § 1033(a).
2. Whether the taxpayer may defer recognition of gain from the involuntary conversion to the extent the proceeds are timely reinvested in qualifying replacement property under § 1033(a).

## Decision

- The IRS concluded that the new office building qualified as property “similar or related in service or use” to the destroyed office building for purposes of I.R.C. § 1033(a).
- The taxpayer could obtain nonrecognition of gain from the involuntary conversion to the extent the § 1033 requirements (including reinvestment timing and amount) were satisfied.

## Legal Principles

- I.R.C. § 1033(a) permits nonrecognition of gain when involuntary conversion proceeds are used, within the statutory replacement period, to acquire replacement property “similar or related in service or use.”
- For income-producing rental real estate, similarity focuses on continuity of the property’s overall income-producing function and its relationship to the taxpayer’s investment or income-producing activity.
- Replacement property need not replicate the converted property in every respect; a partial change in use (including mixed owner-occupancy and leasing) does not preclude § 1033 treatment if the property’s basic commercial office/income-producing character is maintained.

## Conclusion

The IRS determined that a bank’s reinvestment of insurance proceeds from a tornado-destroyed leased office building into a new office building—used partly for banking operations and partly leased under similar terms—satisfied the “similar or related in service or use” requirement of I.R.C. § 1033(a), allowing gain deferral if statutory reinvestment conditions were met.


Rev. Rul. 79-261, 1979-2 C.B. 295 (1979)