Condemnations are involuntary conversions in which property is taken by the federal, state, or local government, or a private organization that has the legal right to take it, without the owner’s consent. The owner receives a condemnation award in the form of money or property, and the conversion is treated as a forced sale for income tax purposes.
Threat of Condemnation
A threat of condemnation exists when you have reason to believe that if you do not sell your property voluntarily, it will be condemned, based on what you have been told by a government representative or public official authorized to acquire property for public use. Your property may also be considered to be under the threat of condemnation if you learn of the decision to acquire your property through the news media and this is confirmed by a government representative or public official.
If you sell your property to someone else, when it is under the threat of condemnation, that sale may be treated as an involuntary conversion for income tax purposes. And if the buyer of your property is aware of the threat of condemnation and sells the property to the government representative or public authority, that sale will also be treated as an involuntary conversion.
If you also voluntarily sell property that is not condemned or under the threat of condemnation, but has a substantial economic relationship to property that is condemned, the sale of that related property may also be treated as an involuntary conversion. The properties may be part of the same economic unit, such as your business property, for example. In this case, you can postpone any gain realized on the sale of the economically related property by buying replacement property.
Gain or Loss from Condemnation
Your gain or loss from a condemnation is the difference between your condemnation award (the money or value of the property you receive) and your adjusted basis in the property. If your net condemnation award is greater, you have a gain. You can postpone recognition of the gain for tax purposes by buying replacement property. If only part of your property is condemned, you can postpone any gain by treating the cost of restoring that part of your property to its former usefulness as the cost of replacement property.
If your adjusted basis is greater than your condemnation award, you have a loss. A loss on property held for personal use is not deductible. But a loss on property held for investment, business, or income-producing activities is deductible in the year of the loss.
There is a “Worksheet for Condemnations” in Internal Revenue Service (IRS) Publication 544, Sales and Other Dispositions of Assets, that will help you calculate the gain from severance damages (see below), the gain or loss from the condemnation award, the amount of gain that must be recognized, and the gain that can be postponed.
Condemnation of Your Main Home
A condemnation of your main home would have the same tax treatment of a sale: you can exclude up to $250,000 ($500,000 if married filing jointly) of any gain realized, if you qualify. If your gain is more than the exclusion amount, you can postpone recognition of the gain for tax purposes by buying replacement property (another home in this case).