What Are Condemnation Taxes in Texas?
If your property was taken by eminent domain, you may owe taxes on the “just compensation” received.
When a government agency or other entity with the power of eminent domain acquires or condemns private property, the Landowner is entitled to “just compensation” for the value of the property taken. This compensation or a certain portion of it, is paid as the “purchase price” for the condemned property (easement, right-of-way or fee simple portion of land). Eminent domain involves the transfer of real estate title in exchange for the payment of compensation which the Internal Revenue Code (the “IRS Code”) typically treats as an ordinary taxable sale of property.
Therefore, the IRS considers the “just compensation” received by a Landowner as a “gain” for which taxes should be paid. The compensation received by a Landowner can be categorized as income from the sale of real estate and also a portion of the compensation as miscellaneous income, if a portion of the taking is temporary.
Ways of Minimizing Condemnation Taxes
As a Landowner, if you are interested in possibly minimizing the tax consequences of a condemnation action, the IRS Code contains a nonrecognition provision in Section 1033 which allows for certain exceptions to taxation for property taken by eminent domain. Section 1033 is similar to the Section 1031 nonrecognition IRS Code provision.
Section 1033: Involuntary Conversions – Nonrecognition of Gains from the Transfer of Condemned Property
Under Section 1031, when a Landowner voluntarily sells real estate, the Landowner can reinvest the proceeds from the sale into like property and avoid paying income tax on the gains from the sale. This concept is typically applicable when you sell your home and use the proceeds to buy a new home. The capital gains from the sell of your home are not taxable if you use those proceeds to buy your next house within a certain period of time.
Section 1033 contains similar timing rules for condemned property and new property to be purchased.
Under Section 1033, property owners are eligible for nonrecognition of gains for tax purposes if:
Their property is condemned, or there is a “threat of imminence” of condemnation;
They replace the condemned property within a specified time period; and,
The replacement property is “eligible property” under Section 1033.
However, not all compensation received by a Landowner in a condemnation proceeding is eligible for a 1033 exchange. Some of the following forms of compensation that may not be eligible for the Section 1033 exchange include:
Interest, delay damages. lost business profits, damages for the destruction of the Landowner’s property, relocation costs and several of types of other expenses.
Consult an Expert in Condemnation Taxes before the Award
Often Landowners will receive condemnation award or damages as a lump sum. Condemnors or special commissioners will not allocate the compensation received into capital gain taxable vs. regular income taxable (or 1033 exchange eligible or non-1033 exchange eligible). Therefore, if possible, before agreeing to an award in a condemnation case, consult an experienced tax advisor and/or attorney to review and understand the tax consequences and possible tax strategies to implement.
If we can help you plan for condemnation taxes and assist you through condemnation proceedings, please call Attorney Philip Hundl at 800–929-1725. He also meets clients at offices in Fulshear, Wharton, and El Campo, Texas.