Severance damages are paid if part of your property is condemned and as a result of the condemnation the value of the part of the property you keep is reduced. For example, if your property is condemned in order to build a highway that passes by or through your land, and as a result of the highway construction you have to make repairs to the part of your property you keep, the amounts you receive to cover those costs would be considered severance damages. These payments are not considered to be part of the condemnation award for purposes of determining gain or loss on the condemnation, provided the severance damages are specified in writing in the condemnation agreement.
Severance damages are treated as a reduction of your basis in the remaining property after a condemnation. If the severance damages are for a specific part of the remaining property, you should reduce your basis in that part of the property. And, if the severance damages you receive are more than your adjusted basis in the property, you have a gain. If you buy replacement property, you can choose to postpone the gain.
The severance damages you receive should be reduced by the expenses you incur in order to obtain the damages. These expenses could include legal costs, appraisal fees, or engineering expenses. Also, your severance damages may have to be reduced by any special assessment charged on your remaining property after a condemnation. For example:
Part of your property is condemned in order to widen a street. You are granted a condemnation award of $8,000 for a strip of your land, and severance damages of $1,000 for the remaining part of the property that you keep.
You spend $300 in order to obtain the severance damages.
The city charges you a special assessment of $900 on your remaining property for the street improvement.
The city pays you $8,100: the condemnation award of $8,000 plus the severance damages of $1,000, less the special assessment of $900.
Your severance damages of $1,000 are reduced by your expenses of $300 to arrive at your net severance damages of $700. This is then reduced to zero by subtracting $700 of the special assessment of $900.
This leaves a balance of $200 ($900 minus $700) from the special assessment that reduces the condemnation award to a net amount of $7,800 ($8,000 minus $200). This $7,800 is the amount that would be used to determine if you have a net gain or loss on the condemnation.