To postpone a gain on condemnation, you must buy replacement property for the specific purpose of replacing the condemned property. In order to qualify, the replacement property must be similar or related in service and use to the property that was condemned. This is determined based on whether you were an owner-user of the condemned property, or an owner-investor.
For example, if you used the condemned property as your home, the replacement property must also be used as your home, and not as a business. If the replacement property is business or investment property, it must serve the same purpose as the condemned property. If the condemned property was rental property, the replacement property you purchase must be similar in terms of the management activities you carry out with respect to the property, the kind of services you provide to tenants, and the nature of the associated business risks to you.
Replacement Period
In order to postpone recognition of a gain from condemnation, you must buy the replacement property within a certain period of time called the replacement period. The replacement period starts on the earlier of the date on which you dispose of the condemned property, or the date on which the threat of condemnation begins. The replacement period ends 2 years after the end of the tax year in which you realize any part of the gain on the condemnation. If the condemned property was real property used for business or investment purposes, the replacement period extends to 3 years. And, if the condemned property was in the New York Liberty Zone, the replacement period is 5 years.
The year in which you realize any gain on the condemnation is when the payments you receive exceed your adjusted basis in the property, if you are on the cash basis. The replacement period starts to run even if these are advance payments and the final amount of the condemnation award has not yet been determined. Once the payments received are more than your basis in the property, the replacement period begins.
If you are an accrual basis taxpayer, the period in which you realize a gain on the condemnation is when all the events that determine the amount of the condemnation award have occurred and the amount of the award can be determined with reasonable accuracy, or when you actually or constructively receive the award, whichever year comes first.
If you purchased your replacement property after there was a threat of condemnation but before the property was actually condemned, and you still have the replacement property at the time of the actual condemnation, you have met the replacement period test. But property purchased before there was a threat of condemnation is not considered to have been purchased during the replacement period.
How to Report Your Election to Postpone the Gain
When you have a gain on a condemnation and elect to postpone the gain by purchasing replacement property, you need to file a statement with your tax return for the year in which you realize the gain, stating your election to postpone the gain and including all necessary details. If you purchase the replacement property after you have filed your tax return for the year in which you realized the gain, you should also attach a statement to your return for that year, with details on the replacement property.