Volume 3 Issue 2-- March/April 1999
No, you haven't been condemned -- yet -- for that tacky sweater you wore to last year's Christmas party. Your property, however, could be condemned for simply being adjacent to an expanding roadway. Governments, with their sovereign powers, have the authority to take real property for a host of reasons, such as to make way for roads or power lines.
While some owners object strongly to losing their home/castle, Governmental taking of property by condemnation is legal, if the "Taker" (the Government) adequately compensates the "Takee" (the property owner). (What constitutes "adequate" compensation has been, and will continue to be, the subject of endless dispute, but this newsletter is not about that).
Without proper planning, a condemnation can result in a significant income tax bill. What many don' know is that they DO NOT HAVE TO PAY INCOME TAX on the condemnation funds received if certain choices are made. In other words, you or your business (which shouldn't own land, see Tax & Business Insights, May/June 1995), can elect to defer the income tax on the condemnation gain.
Let's say, you purchased Green Acres, a tree farm, for $50,000 in 1955, and now the State is offering you $1,100,000 for the property because it is needed for a new highway interchange. If you receive the condemnation proceeds and spend them on something other than replacement real estate, you will owe State and Federal income tax on the gain, $1,050,000 (ignoring closing costs, depreciation, etc.).
What can you do to defer the tax? You can elect to replace Green Acres with other real estate using special provisions of the tax law. Some call this type of reinvestment a "condemnation rollover."
In plain language, here's how it works. When the condemnation proceeds are received, they are deemed to have been "rolled-over" (reinvested in real estate) if the recipient does nothing. Yes, as odd as it sounds, if you receive condemnation proceeds (cash) and do nothing, it is assumed you want to roll the proceeds over into other real estate during a three-year period.
What type of replacement real estate can you purchase? Nearly any kind. Is it possible to go from Green Acres to a condominium in New York? Yes. What about a farm in Georgia? Yes, again. Can you buy multiple parcels of real estate or condominiums in different states? Again, yes!
You may be asking, "If I don't have to do anything, how does the Government know I reinvested?" Here is where the reporting begins. As replacement property is purchased during the three-year period, your tax returns should include attachments telling the IRS how basis is being allocated. Basis is roughly what you paid for the condemned property, plus improvements, minus depreciation.
In the above example, the basis in Green Acres is $50,000. That will be the combined basis in all of the replacement property. Effectively, the tax law provisions allow you to reinvest tax-free and have the same old basis apply if, or when, the replacement property is sold. In essence, the tax that might have been paid on the condemnation proceeds is deferred.
Suppose you purchased five condos in Florida with your Green Acres condem-nation proceeds and hold onto them. Suppose these properties are worth $1,100,000 at the time of your death, and your heirs sell them for $1,100,000. There may be no income tax due, assuming no appreciation or deductions (such as depreciation) in the intervening period between the death and sale date.
What about the equipment located on Green Acres? Some of the same concepts apply, but the reinvestment period for the equipment is two (not three) years and the reinvestment must be in property that is "similar or related in service or use." The IRS provisions concerning tax-free rollovers for equipment replacement are less expansive than the similar provisions for real estate.
What if your home was on Green Acres? Can you exclude the gain you could have excluded? Yes. If you were married, for example, you could exclude $500,000 under current law and then roll over the remainder of the proceeds, $600,000.
While having property condemned is inconvenient, you can avoid or reduce the tax bite on
condemnationn proceeds with proper planning. Good planning pays, and Newland & Associates can help
you make the choices best for you.
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