The Taxman Cometh: Conveyance Language and its Secondary Tax Implications in the Event of Involuntary Conversion

By Rebecca McDonough, Executive Editor

The Fifth Amendment provides property owners with the guarantee of just compensation when private property is taken for public use by a government entity.[1] While legal scholars have debated the definitions of “just compensation” and “public use,” the language included in condemnation conveyance documents and secondary tax implications of such language have yet to be explored.[2] The Internal Revenue Code specifically provides a taxpayer with the means of deferring his gain “where he is compelled to give up such property because of circumstances beyond his control.”[3]

Beyond the reporting requirements, additional language in applicable conveyance documents, such as purchase agreements or deeds, could be employed as evidentiary support for a taxpayer’s claim of involuntary conversion and nonrecognizable or deferred gain. Specifically, conveyance documents including the phrase “conveyed under threat of eminent domain” or “conveyed in lieu of eminent domain proceedings” could be the new normal in federal, state or municipal property acquisitions.

As a general rule, property involuntarily converted into money, through the receipt of a condemnation award, can be deferred for tax reporting purposes if the taxpayer purchases “property similar or related in service” to the converted property within two years of the date of involuntary conversion.[4] The condemnation award must be reinvested in replacement property.[5] If the award is not reinvested, it is a taxable gain and must be reported as such by the taxpayer.[6]

A threat of condemnation exists “if the taxpayer might reasonably believe from representations of government agents and from surrounding circumstances that condemnation [is] likely to take place if he [does] not sell his property.”[7] The Internal Revenue Service provides that any oral statements upon which the taxpayer relied may have to be supported by written confirmation to satisfy the requirements for elected deferral.[8] Individual states have their own requirements for how governmental entities and agencies must go about acquiring private property.[9] In Ohio, for example, the triggering event for a threat of condemnation occurs when the taxpayer receives written notice of the government’s intent to acquire his property.[10]

The standard form of notice of intent to acquire under the Ohio Revised Code includes a section which provides, “[i]f you do not accept this offer, and we cannot come to an agreement on the acquisition of (your property) (an easement), ________________ (agency) has the right to file suit to acquire the (property) (easement) by eminent domain in the county in which the property is located.”[11] Upon receipt of such notice, a taxpayer could reasonably interpret this language to indicate that the property would be acquired through the government entity’s eminent domain or condemnation power if the taxpayer does not voluntarily convey it.

Manatee County, Florida is the only jurisdiction which uses specific eminent domain language in property conveyance documents.[12] The inclusion of “under threat of and in lieu of eminent domain proceedings” language is not for tax purposes, but to exempt the documents from county recording fees.[13] Expanding the application of this language beyond Manatee County and across other jurisdictions will provide additional evidentiary support to individuals seeking to invoke their deferral right under I.R.C. § 1033.

To qualify for a deferral, the taxpayer must reinvest the condemnation award in similar property within two years and he must include notice of his election to defer with his tax return for the year in which the involuntary conversion occurred.[14] However, when reporting his election to defer the taxpayer is only required to include “all necessary details.”[15] Having satisfied the statutory and jurisdictional requirements to exercise its eminent domain power, the governmental entity benefits from the acquisition of the taxpayer’s property. In turn, the inclusion of eminent domain language in the conveyance documents benefits the taxpayer should he wish to reinvest the condemnation award and defer the gain. Considering the ambiguity of “all necessary details,” adding “conveyed under threat of eminent domain” or “conveyed in lieu of eminent domain proceedings” provides the taxpayer with supplementary evidentiary support should any issues arise regarding his elected deferral.

[1] U.S. Const. amend. V.

[2] See Patricia E. Salkin & Lora A. Lucero, Community Redevelopment, Public Use, and Eminent Domain, 37 Urb. Law. 201 (2005); Steve P. Calandrillo, Eminent Domain Economics: Should “Just Compensation” Be Abolished, and Would “Takings Insurance” Work Instead, 64 Ohio St. L.J. 451 (2003).

[3] S & B Realty Co. v. Comm’r of Internal Revenue, 54 T.C. 893, 871 (1970).

[4] I.R.C. § 1033(a) (LexisNexis 2019).

[5] I.R.C § 1033(b) (LexisNexis 2019).

[6] Mark W. Cochran, Should Personal Injury Damage Awards Be Taxed?, 38 Case W. Res. 43, 47 (1988).

[7] Ranier Cos., Inc. v. Comm’r of Internal Revenue, 61 T.C. 68, 76 (1973).

[8] Internal Revenue Serv., Dep’t of the Treasury, Pub. 544, Sales and Other Dispositions of Assets 6 (Mar. 13, 2018), https://www.irs.gov/pub/irs-pdf/p544.pdf.

[9] See Fifty-State Survey: The Law of Eminent Domain (William G. Blake ed., 2012).

[10] Ohio Rev. Code Ann. § 163.04(A) (LexisNexis 2019).

[11] Ohio Rev. Code Ann. § 163.041 (Lexis Nexis 2019).

[12] Joaquin Servia, Manatee Cty. Prop. Mgmt. Dep’t, Contract for Sale and Purchase for Permanent Easement (2013), https://www.mymanatee.org/published/August%2013,%202013%20-%20Regular%20Meeting%20on%20Tuesday,%20August%2013,%202013/634F0054-633A-4A5F-8031-B430A631D6C5.pdf.

[13] Manatee Cty. Prop. Mgmt. Dep’t, Permanent Utilities Easement (2013). https://www.mymanatee.org/UserFiles/Servers/Server_7588306/File/Departments/Building%20&%20Development%20Services/Planning%20&%20Development/Applications%20Forms%20Fees/Subdiv/Drainage_Utilites%20Easement_RepCapacity_Rev_8_02_13_CAO-803.2.%20%20rev.pdf.

[14] Internal Revenue Serv., Dep’t of the Treasury, Pub. 544, at 10.

[15] Id.