Does eminent domain compensation affect your taxes? Yes.
There are many different aspects of eminent domain that property owners must consider when they are facing this type of stressful situation. Your immediate concern upon receiving a condemnation notice is to seek legal advice to ensure your rights are being defended. However, there are tax considerations that you will need to understand before and after the negotiations settle.
It is in your best interest to involve an eminent domain attorney and get the advice of a tax consultant you trust as soon as you receive a government notice.
In addition, here are a few things to know about reporting and paying taxes on your eminent domain award.
What is Eminent Domain?
Under the Fifth Amendment of the Constitution of the United States, government entities have the right to lay claim to residential or commercial properties for public use.
The major condition regarding such an eminent domain action is that the law requires the government to provide “just compensation” to landowners in return for taking the land. Compensation can vary significantly, depending on the type of property, the use of the property, and whether it will constitute a complete or partial taking.
If the government makes you an offer for part or all of your land, contact an experienced eminent domain attorney right away. An attorney can negotiate with government representatives to ensure you receive a fair settlement offer. Once your attorney negotiates fair compensation, the government will pay the landowner, who must promptly vacate the property.
Do You Have to Pay Taxes on Eminent Domain Payments?
You’ll want a fierce property rights negotiator on your side when it comes to dealing with a government agency. It’s the best way to vastly improve the compensation you are awarded for your property. But your responsibilities don’t stop once you have accepted payment and vacated the land.
When tax season comes, landowners who receive condemnation compensation may face a surprise—a significantly higher tax liability than usual. Compensation received for condemned property is taxable, just like the proceeds of any other type of real estate sale.
Tax Implications of Eminent Domain Compensation
Property owners should plan to face a tax liability for any taxable gain that occurred regarding the property. This is similar to any other land or property sale. You have a duty to report the compensation amount and how much of that award is considered net profit, or a taxable gain.
Taxable gain happens when the compensation for the property is more than the tax basis. You can figure out the tax basis of your land by adding the costs of improvements to the original price you paid for the land and subtracting any depreciation or losses associated with the property.
Once you have this total, you must subtract that amount from the compensation you received to find your total taxable gain or profit.
For example, consider the following:
Original price: $200,000 +
Cost of improvements: $50,000 –
Depreciation: $10,000 =
Tax basis: $240,000
Government compensation: $250,000
Taxable gain: $10,000
In this situation, you would have to pay taxes on an additional $10,000.
This may not seem like much, but it can add up to a substantial increase in your tax liability, depending on the original purchase price of the property and your regular income. A larger taxable gain is especially common if you have owned the property for many decades or if the property experienced a substantial increase in value since you purchased it.
This taxable amount may also have different long-term liabilities if you choose not to reinvest the money you received in another property.
How Property Tax Assessments Change after Eminent Domain
Understanding how to report eminent domain on your tax return can also be further complicated if only a portion of your property has been condemned. You must work through the same type of calculations while also taking into account the percentage of the land being sold, and what part you retain control of, to arrive at your correct tax basis and gain.
You might also expect the tax basis of your remaining land and property to change in the coming years as the value of the surrounding and seized property changes due to the planned development.
Potential Tax Benefits
Fortunately, you can plan ahead to avoid a giant tax bill come tax season. For instance, your state may have a program that allows you to use the compensation you received to purchase another piece of property within a certain amount of time. The IRS may also allow you to conduct a 1033 exchange, which avoids the taxable gains tax, though you must meet recent requirements for this exchange.
An experienced eminent domain attorney can advise you as to your options and the possible tax implications of your transaction.
Protect Your Financial Interests
When you’re facing eminent domain, it takes a village to protect your interests. Reach out to Sever Walker Padgitt the moment you receive a condemnation notice, but don’t forget to include your tax advisor as we help you navigate the legal system and negotiate for reasonable compensation. They can make sure you understand how to report eminent domain on a tax return and maximize any tax benefits and exceptions you may be entitled to.
Call the Condemnation Attorneys at Sever Walker Padgitt for Assistance
Tax liability is only one of many issues that may arise during an eminent domain action. At the law office of Sever Walker Padgitt, LLP, our eminent domain lawyers are committed to protecting the rights of landowners, including helping them prevent as much financial loss as possible due to the eminent domain action.
Please call (888) 318-3761 or contact us online today to discuss the many ways we may help you.
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