An involuntary conversion occurs when your property is destroyed, stolen, condemned, or disposed of under the threat of condemnation and you receive other property or money in payment, such as insurance or a condemnation award. Involuntary conversions are also called involuntary exchanges.
Gain or loss from an involuntary conversion of your property is usually recognized for tax purposes unless the property is your main home. You report the gain or deduct the loss on your tax return for the year you realize it. You cannot deduct a loss from an involuntary conversion of property you held for personal use unless the loss resulted from a casualty or theft.
However, depending on the type of property you receive, you may not have to report a gain on an involuntary conversion. Generally, you do not report the gain if you receive property that is similar or related in service or use to the converted property. Your basis for the new property is the same as your basis for the converted property. This means that the gain is deferred until a taxable sale or exchange occurs.
If you receive money or property that is not similar or related in service or use to the involuntarily converted property and you buy qualifying replacement property within a certain period of time, you can elect to postpone reporting the gain.
This publication explains the treatment of a gain or loss from a condemnation or disposition under the threat of condemnation. If you have a gain or loss from the destruction or theft of property, see Publication 547.taxmap/pubs/p544-004.htm#en_us_publink100072305
A condemnation is the process by which private property is legally taken for public use without the owner's consent. The property may be taken by the federal government, a state government, a political subdivision, or a private organization that has the power to legally take it. The owner receives a condemnation award (money or property) in exchange for the property taken. A condemnation is like a forced sale, the owner being the seller and the condemning authority being the buyer. taxmap/pubs/p544-004.htm#en_us_publink100072306
A local government authorized to acquire land for public parks informed you that it wished to acquire your property. After the local government took action to condemn your property, you went to court to keep it. But, the court decided in favor of the local government, which took your property and paid you an amount fixed by the court. This is a condemnation of private property for public use.taxmap/pubs/p544-004.htm#en_us_publink100072307
A threat of condemnation exists if a representative of a government body or a public official authorized to acquire property for public use informs you that the government body or official has decided to acquire your property. You must have reasonable grounds to believe that, if you do not sell voluntarily, your property will be condemned.
The sale of your property to someone other than the condemning authority will also qualify as an involuntary conversion, provided you have reasonable grounds to believe that your property will be condemned. If the buyer of this property knows at the time of purchase that it will be condemned and sells it to the condemning authority, this sale also qualifies as an involuntary conversion. taxmap/pubs/p544-004.htm#en_us_publink100072308
A threat of condemnation exists if you learn of a decision to acquire your property for public use through a report in a newspaper or other news medium, and this report is confirmed by a representative of the government body or public official involved. You must have reasonable grounds to believe that they will take necessary steps to condemn your property if you do not sell voluntarily. If you relied on oral statements made by a government representative or public official, the Internal Revenue Service (IRS) may ask you to get written confirmation of the statements. taxmap/pubs/p544-004.htm#en_us_publink100072309
Your property lies along public utility lines. The utility company has the authority to condemn your property. The company informs you that it intends to acquire your property by negotiation or condemnation. A threat of condemnation exists when you receive the notice.taxmap/pubs/p544-004.htm#en_us_publink100072310
A voluntary sale of your property may be treated as a forced sale that qualifies as an involuntary conversion if the property had a substantial economic relationship to property of yours that was condemned. A substantial economic relationship exists if together the properties were one economic unit. You also must show that the condemned property could not reasonably or adequately be replaced. You can elect to postpone reporting the gain by buying replacement property. See Postponement of Gain, later. taxmap/pubs/p544-004.htm#en_us_publink100072311
If your property was condemned or disposed of under the threat of condemnation, figure your gain or loss by comparing the adjusted basis of your condemned property with your net condemnation award.
If your net condemnation award is more than the adjusted basis of the condemned property, you have a gain. You can postpone reporting gain from a condemnation if you buy replacement property. If only part of your property is condemned, you can treat the cost of restoring the remaining part to its former usefulness as the cost of replacement property. See Postponement of Gain, later.
If your net condemnation award is less than your adjusted basis, you have a loss. If your loss is from property you held for personal use, you cannot deduct it. You must report any deductible loss in the tax year it happened.
You can use Part 2 of Table 1-3 to figure your gain or loss from a condemnation award.
If you have a gain because your main home is condemned, you generally can exclude the gain from your income as if you had sold or exchanged your home. You may be able to exclude up to $250,000 of the gain (up to $500,000 if married filing jointly). For information on this exclusion, see Publication 523. If your gain is more than you can exclude but you buy replacement property, you may be able to postpone reporting the rest of the gain. See Postponement of Gain, later.
Table 1-3. Worksheet for Condemnations
|Part 1. Gain from severance damages.|
If you did not receive severance damages, skip Part 1 and go to Part 2.
|1.||Enter gross severance damages received|| |
|2.||Enter your expenses in getting severance damages|| |
|3.||Subtract line 2 from line 1. If less than zero, enter -0-|| |
|4.||Enter any special assessment on remaining property taken out of your award|| |
|5.||Net severance damages. Subtract line 4 from line 3. If less than zero, enter -0-|| |
|6.||Enter the adjusted basis of the remaining property|| |
|7.||Gain from severance damages. Subtract line 6 from line 5. If less than zero, enter -0-|| |
|8.||Refigured adjusted basis of the remaining property. Subtract line 5 from line 6. If less than zero, enter -0-|| |
|Part 2. Gain or loss from condemnation award.|| |
|9.||Enter the gross condemnation award received|| |
|10.||Enter your expenses in getting the condemnation award|| |
|11.||If you completed Part 1, and line 4 is more than line 3, subtract line 3 from line 4. If you did not complete Part 1, but a special assessment was taken out of your award, enter that amount. Otherwise, enter -0- || |
|12.||Add lines 10 and 11|| |
|13.||Net condemnation award. Subtract line 12 from line 9 || |
|14.||Enter the adjusted basis of the condemned property|| |
|15.||Gain from condemnation award. If line 14 is more than line 13, enter -0-. Otherwise, subtract line 14 from |
line 13 and skip line 16
|16.||Loss from condemnation award. Subtract line 13 from line 14 || |
| ||(Note: You cannot deduct the amount on line 16 if the condemned property was held for personal use.) || |
|Part 3. Postponed gain from condemnation. |
(Complete only if line 7 or line 15 is more than zero and you bought qualifying replacement property or made expenditures to restore the usefulness of your remaining property.)
|17.||If you completed Part 1, and line 7 is more than zero, enter the amount from line 5. Otherwise, enter -0-|| |
|18.||If line 15 is more than zero, enter the amount from line 13. Otherwise, enter -0-|| |
|19.||Add lines 17 and 18. If the condemned property was your main home, subtract from this total the gain you excluded from your income and enter the result || |
|20.||Enter the total cost of replacement property and any expenses to restore the usefulness of your remaining property|| |
|21.||Subtract line 20 from line 19. If less than zero, enter -0-|| |
|22.||If you completed Part 1, add lines 7 and 15. Otherwise, enter the amount from line 15. If the condemned property was your main home, subtract from this total the gain you excluded from your income and enter the result || |
|23.||Recognized gain. Enter the smaller of line 21 or line 22. || |
|24.||Postponed gain. Subtract line 23 from line 22. If less than zero, enter -0- || |
A condemnation award is the money you are paid or the value of other property you receive for your condemned property. The award is also the amount you are paid for the sale of your property under threat of condemnation.taxmap/pubs/p544-004.htm#en_us_publink100072315
Amounts taken out of the award to pay your debts are considered paid to you. Amounts the government pays directly to the holder of a mortgage or lien against your property are part of your award, even if the debt attaches to the property and is not your personal liability. taxmap/pubs/p544-004.htm#en_us_publink100072316
The state condemned your property for public use. The award was set at $200,000. The state paid you only $148,000 because it paid $50,000 to your mortgage holder and $2,000 accrued real estate taxes. You are considered to have received the entire $200,000 as a condemnation award.taxmap/pubs/p544-004.htm#en_us_publink100072317
If the condemning authority pays you interest for its delay in paying your award, it is not part of the condemnation award. You must report the interest separately as ordinary income. taxmap/pubs/p544-004.htm#en_us_publink100072318
Payments you receive to relocate and replace housing because you have been displaced from your home, business, or farm as a result of federal or federally assisted programs are not part of the condemnation award. Do not include them in your income. Replacement housing payments used to buy new property are included in the property's basis as part of your cost. taxmap/pubs/p544-004.htm#en_us_publink100072319
A net condemnation award is the total award you received, or are considered to have received, for the condemned property minus your expenses of obtaining the award. If only a part of your property was condemned, you also must reduce the award by any special assessment levied against the part of the property you retain. This is discussed later under Special assessment taken out of award. taxmap/pubs/p544-004.htm#en_us_publink100072320
Severance damages are not part of the award paid for the property condemned. They are paid to you if part of your property is condemned and the value of the part you keep is decreased because of the condemnation.
For example, you may receive severance damages if your property is subject to flooding because you sell flowage easement rights (the condemned property) under threat of condemnation. Severance damages also may be given to you if, because part of your property is condemned for a highway, you must replace fences, dig new wells or ditches, or plant trees to restore your remaining property to the same usefulness it had before the condemnation.
The contracting parties should agree on the specific amount of severance damages in writing. If this is not done, all proceeds from the condemning authority are considered awarded for your condemned property.
You cannot make a completely new allocation of the total award after the transaction is completed. However, you can show how much of the award both parties intended for severance damages. The severance damages part of the award is determined from all the facts and circumstances. taxmap/pubs/p544-004.htm#en_us_publink100072321
You sold part of your property to the state under threat of condemnation. The contract you and the condemning authority signed showed only the total purchase price. It did not specify a fixed sum for severance damages. However, at settlement, the condemning authority gave you closing papers showing clearly the part of the purchase price that was for severance damages. You may treat this part as severance damages. taxmap/pubs/p544-004.htm#en_us_publink100072322
Your net severance damages are treated as the amount realized from an involuntary conversion of the remaining part of your property. Use them to reduce the basis of the remaining property. If the amount of severance damages is based on damage to a specific part of the property you kept, reduce the basis of only that part by the net severance damages.
If your net severance damages are more than the basis of your retained property, you have a gain. You may be able to postpone reporting the gain. See Postponement of Gain, later.
You can use Part 1 of Table 1-3 to figure any gain from severance damages and to refigure the adjusted basis of the remaining part of your property.
To figure your net severance damages, you first must reduce your severance damages by your expenses in obtaining the damages. You then reduce them by any special assessment (described later) levied against the remaining part of the property and retained out of the award by the condemning authority. The balance is your net severance damages.taxmap/pubs/p544-004.htm#en_us_publink100072325
Subtract the expenses of obtaining a condemnation award, such as legal, engineering, and appraisal fees, from the total award. Also, subtract the expenses of obtaining severance damages, that may include similar expenses, from the severance damages paid to you. If you cannot determine which part of your expenses is for each part of the condemnation proceeds, you must make a proportionate allocation. taxmap/pubs/p544-004.htm#en_us_publink100072326
You receive a condemnation award and severance damages. One-fourth of the total was designated as severance damages in your agreement with the condemning authority. You had legal expenses for the entire condemnation proceeding. You cannot determine how much of your legal expenses is for each part of the condemnation proceeds. You must allocate one-fourth of your legal expenses to the severance damages and the other three-fourths to the condemnation award.taxmap/pubs/p544-004.htm#en_us_publink100072327
When only part of your property is condemned, a special assessment levied against the remaining property may be retained by the governing body out of your condemnation award. An assessment may be levied if the remaining part of your property benefited by the improvement resulting from the condemnation. Examples of improvements that may cause a special assessment are widening a street and installing a sewer.
To figure your net condemnation award, you must reduce the amount of the award by the assessment retained out of the award. taxmap/pubs/p544-004.htm#en_us_publink100072328
To widen the street in front of your home, the city condemned a 25-foot deep strip of your land. You were awarded $5,000 for this and spent $300 to get the award. Before paying the award, the city levied a special assessment of $700 for the street improvement against your remaining property. The city then paid you only $4,300. Your net award is $4,000 ($5,000 total award minus $300 expenses in obtaining the award and $700 for the special assessment retained).
If the $700 special assessment was not retained out of the award and you were paid $5,000, your net award would be $4,700 ($5,000 − $300). The net award would not change, even if you later paid the assessment from the amount you received.taxmap/pubs/p544-004.htm#en_us_publink100072329
If severance damages are included in the condemnation proceeds, the special assessment retained out of the severance damages is first used to reduce the severance damages. Any balance of the special assessment is used to reduce the condemnation award. taxmap/pubs/p544-004.htm#en_us_publink100072330
You were awarded $4,000 for the condemnation of your property and $1,000 for severance damages. You spent $300 to obtain the severance damages. A special assessment of $800 was retained out of the award. The $1,000 severance damages are reduced to zero by first subtracting the $300 expenses and then $700 of the special assessment. Your $4,000 condemnation award is reduced by the $100 balance of the special assessment, leaving a $3,900 net condemnation award.taxmap/pubs/p544-004.htm#en_us_publink100072331
If you used part of your condemned property as your home and part as business or rental property, treat each part as a separate property. Figure your gain or loss separately because gain or loss on each part may be treated differently.
Some examples of this type of property are a building in which you live and operate a grocery, and a building in which you live on the first floor and rent out the second floor.taxmap/pubs/p544-004.htm#en_us_publink100072332
You sold your building for $24,000 under threat of condemnation to a public utility company that had the authority to condemn. You rented half the building and lived in the other half. You paid $25,000 for the building and spent an additional $1,000 for a new roof. You claimed allowable depreciation of $4,600 on the rental half. You spent $200 in legal expenses to obtain the condemnation award. Figure your gain or loss as follows.
| || ||Resi-|
|1)||Condemnation award received||$12,000||$12,000|
|2)||Minus: Legal expenses, $200||100||100|
|3)||Net condemnation award||$11,900||$11,900|
|4)|| Adjusted basis:|| || |
| ||1/2 of original cost, $25,000 ||$12,500||$12,500|
| ||Plus: 1/2 of cost of roof, $1,000 ||500||500|
| || Total||$13,000||$13,000|
|5)||Minus: Depreciation|| ||4,600|
|6)||Adjusted basis, business part|| ||$8,400|
|7)||(Loss) on residential property||($1,100)|| |
|8)||Gain on business property||$3,500|
|The loss on the residential part of the property is not deductible.|
Do not report the gain on condemned property if you receive only property that is similar or related in service or use to the condemned property. Your basis for the new property is the same as your basis for the old. taxmap/pubs/p544-004.htm#en_us_publink100072334
You ordinarily must report the gain if you receive money or unlike property. You can elect to postpone reporting the gain if you buy property that is similar or related in service or use to the condemned property within the replacement period, discussed later. You also can elect to postpone reporting the gain if you buy a controlling interest (at least 80%) in a corporation owning property that is similar or related in service or use to the condemned property. See Controlling interest in a corporation, later.
To postpone reporting all the gain, you must buy replacement property costing at least as much as the amount realized for the condemned property. If the cost of the replacement property is less than the amount realized, you must report the gain up to the unspent part of the amount realized.
The basis of the replacement property is its cost, reduced by the postponed gain. Also, if your replacement property is stock in a corporation that owns property similar or related in service or use, the corporation generally will reduce its basis in its assets by the amount by which you reduce your basis in the stock. See Controlling interest in a corporation, later.
You can use Part 3 of Table 1-3 to figure the gain you must report and your postponed gain.
If you received severance damages for part of your property because another part was condemned and you buy replacement property, you can elect to postpone reporting gain. See Treatment of severance damages, earlier. You can postpone reporting all your gain if the replacement property costs at least as much as your net severance damages plus your net condemnation award (if resulting in gain).
You also can make this election if you spend the severance damages, together with other money you received for the condemned property (if resulting in gain), to acquire nearby property that will allow you to continue your business. If suitable nearby property is not available and you are forced to sell the remaining property and relocate in order to continue your business, see Postponing gain on the sale of related property, next.
If you restore the remaining property to its former usefulness, you can treat the cost of restoring it as the cost of replacement property. taxmap/pubs/p544-004.htm#en_us_publink100072337
If you sell property that is related to the condemned property and then buy replacement property, you can elect to postpone reporting gain on the sale. You must meet the requirements explained earlier under Related property voluntarily sold. You can postpone reporting all your gain if the replacement property costs at least as much as the amount realized from the sale plus your net condemnation award (if resulting in gain) plus your net severance damages, if any (if resulting in gain). taxmap/pubs/p544-004.htm#en_us_publink100072338
Certain taxpayers cannot postpone reporting gain from a condemnation if they buy the replacement property from a related person. For information on related persons, see Nondeductible Loss under Sales and Exchanges Between Related Persons in chapter 2.
This rule applies to the following taxpayers.
- C corporations.
- Partnerships in which more than 50% of the capital or profits interest is owned by
- All others (including individuals, partnerships (other than those in (2)), and S corporations) if the total realized gain for the tax year on all involuntarily converted properties on which there are realized gains is more than $100,000.
For taxpayers described in (3) above, gains cannot be offset with any losses when determining whether the total gain is more than $100,000. If the property is owned by a partnership, the $100,000 limit applies to the partnership and each partner. If the property is owned by an S corporation, the $100,000 limit applies to the S corporation and each shareholder. taxmap/pubs/p544-004.htm#en_us_publink100072339
This rule does not apply if the related person acquired the property from an unrelated person within the replacement period. taxmap/pubs/p544-004.htm#en_us_publink100072340
If you pay a contractor in advance to build your replacement property, you have not bought replacement property unless it is finished before the end of the replacement period (discussed later). taxmap/pubs/p544-004.htm#en_us_publink100072341
To postpone reporting gain, you must buy replacement property for the specific purpose of replacing your condemned property. You do not have to use the actual funds from the condemnation award to acquire the replacement property. Property you acquire by gift or inheritance does not qualify as replacement property. taxmap/pubs/p544-004.htm#en_us_publink100072342
Your replacement property must be similar or related in service or use to the property it replaces.
If the condemned property is real property you held for productive use in your trade or business or for investment (other than property held mainly for sale), but your replacement property is not similar or related in service or use, it will be treated as such if it is like-kind property to be held for productive use in a trade or business or for investment. For a discussion of like-kind property, see Like-Kind Property under Like-Kind Exchanges, later. taxmap/pubs/p544-004.htm#en_us_publink100072343
If you are an owner-user, similar or related in service or use means that replacement property must function in the same way as the property it replaces. taxmap/pubs/p544-004.htm#en_us_publink100072344
Your home was condemned and you invested the proceeds from the condemnation in a grocery store. Your replacement property is not similar or related in service or use to the condemned property. To be similar or related in service or use, your replacement property must also be used by you as your home.taxmap/pubs/p544-004.htm#en_us_publink100072345
If you are an owner-investor, similar or related in service or use means that any replacement property must have the same relationship of services or uses to you as the property it replaces. You decide this by determining all the following information.
- Whether the properties are of similar service to you.
- The nature of the business risks connected with the properties.
- What the properties demand of you in the way of management, service, and relations to your tenants.
You owned land and a building you rented to a manufacturing company. The building was condemned. During the replacement period, you had a new building built on other land you already owned. You rented out the new building for use as a wholesale grocery warehouse. The replacement property is also rental property, so the two properties are considered similar or related in service or use if there is a similarity in all the following areas.
- Your management activities.
- The amount and kind of services you provide to your tenants.
- The nature of your business risks connected with the properties.
Fee simple property you will use in your trade or business or for investment can qualify as replacement property that is similar or related in service or use to a condemned leasehold if you use it in the same business and for the identical purpose as the condemned leasehold.
A fee simple property interest generally is a property interest that entitles the owner to the entire property with unconditional power to dispose of it during his or her lifetime. A leasehold is property held under a lease, usually for a term of years. taxmap/pubs/p544-004.htm#en_us_publink100072348
You can elect to treat an outdoor advertising display as real property. If you make this election and you replace the display with real property in which you hold a different kind of interest, your replacement property can qualify as like-kind property. For example, real property bought to replace a destroyed billboard and leased property on which the billboard was located qualifies as property of a like kind.
You can make this election only if you did not claim a section 179 deduction for the display. You cannot cancel this election unless you get the consent of the IRS.
An outdoor advertising display is a sign or device rigidly assembled and permanently attached to the ground, a building, or any other permanent structure used to display a commercial or other advertisement to the public. taxmap/pubs/p544-004.htm#en_us_publink100072349
Once you designate certain property as replacement property on your tax return, you cannot substitute other qualified property. But, if your previously designated replacement property does not qualify, you can substitute qualified property if you acquire it within the replacement period. taxmap/pubs/p544-004.htm#en_us_publink100072350
You can replace property by acquiring a controlling interest in a corporation that owns property similar or related in service or use to your condemned property. You have controlling interest if you own stock having at least 80% of the combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation. taxmap/pubs/p544-004.htm#en_us_publink100072351
The basis of property held by the corporation at the time you acquired control must be reduced by your postponed gain, if any. You are not required to reduce the adjusted basis of the corporation's properties below your adjusted basis in the corporation's stock (determined after reduction by your postponed gain).
Allocate this reduction to the following classes of property in the order shown below.
- Property that is similar or related in service or use to the condemned property.
- Depreciable property not reduced in (1).
- All other property.
If two or more properties fall in the same class, allocate the reduction to each property in proportion to the adjusted basis of all the properties in that class. The reduced basis of any single property cannot be less than zero.
If your gain from a condemnation of your main home is more than you can exclude from your income (see Main home condemned under Gain or Loss From Condemnations, earlier), you can postpone reporting the rest of the gain by buying replacement property that is similar or related in service or use. The replacement property must cost at least as much as the amount realized from the condemnation minus the excluded gain.
You must reduce the basis of your replacement property by the postponed gain. Also, if you postpone reporting any part of your gain under these rules, you are treated as having owned and used the replacement property as your main home for the period you owned and used the condemned property as your main home. taxmap/pubs/p544-004.htm#en_us_publink1000145983
City authorities condemned your home that you had used as a personal residence for two years prior to the condemnation. The city paid you a condemnation award of $400,000. Your adjusted basis in the property was $80,000. You realize a gain of $320,000 ($400,000 − $80,000). You purchased a new home for $100,000. You can exclude $250,000 of the realized gain from your gross income. The amount realized is then treated as being $150,000 ($400,000 − $250,000) and the gain realized is $70,000 ($150,000 amount realized − $80,000 adjusted basis). You must recognize $50,000 of the gain ($150,000 amount realized − $100,000 cost of new home). The remaining $20,000 of realized gain is postponed. Your basis in the new home is $80,000 ($100,000 cost − $20,000 gain postponed).taxmap/pubs/p544-004.htm#en_us_publink100072353
To postpone reporting your gain from a condemnation, you must buy replacement property within a certain period of time. This is the replacement period.
The replacement period for a condemnation begins on the earlier of the following dates.
- The date on which you disposed of the condemned property.
- The date on which the threat of condemnation began.
The replacement period generally ends 2 years after the end of the first tax year in which any part of the gain on the condemnation is realized. However, see the exceptions below.
If real property held for use in a trade or business or for investment (not including property held primarily for sale) is condemned, the replacement period ends 3 years after the end of the first tax year in which any part of the gain on the condemnation is realized. However, this 3-year replacement period cannot be used if you replace the condemned property by acquiring control of a corporation owning property that is similar or related in service or use. taxmap/pubs/p544-004.htm#en_us_publink100072354
The replacement period ends 5 years after the end of the first tax year in which any part of the gain is realized on the compulsory or involuntary conversion of the following property.
- Property in any Midwestern disaster area compulsorily or involuntarily converted on or after the applicable disaster date as a result of severe storms, tornadoes, or flooding, but only if substantially all of the use of the replacement property is in a Midwestern disaster area.
- Property in the Kansas disaster area compulsorily or involuntarily converted after May 3, 2007, but only if substantially all of the use of the replacement property is in the Kansas disaster area.
- Property in the Hurricane Katrina disaster area compulsorily or involuntarily converted after August 24, 2005, as a result of Hurricane Katrina, but only if substantially all of the use of the replacement property is in the Hurricane Katrina disaster area.
- New York Liberty Zone property compulsorily or involuntarily converted as a result of the September 11, 2001, terrorist attacks, but only if substantially all of the use of the replacement property is in New York City.
If you are affected by a federally declared disaster, the IRS may grant disaster relief by extending the periods to perform certain tax-related acts for 2008, including the replacement period, by up to one year. For more information visithttp://www.irs.gov/newsroom/article/0,,id=108362,00.html
Generally, if the sale or exchange of livestock is due to drought, flood, or other weather-related conditions in an area eligible for federal assistance, the replacement period ends 4 years after the close of the first tax year in which you realize any part of your gain from the sale or exchange.
If the weather-related conditions continue for longer than 3 years, the replacement period may be extended on a regional basis until the end of your first drought-free year for the applicable region. See Notice 2006-82. You can find Notice 2006-82 on page 529 of Internal Revenue Bulletin 2006-39 at www.irs.gov/pub/irs-irbs/irb06-39.pdf
Each year, the IRS publishes a list of counties, districts, cities, or parishes for which exceptional, extreme, or severe drought was reported during the preceding 12 months. If you qualified for a 4-year replacement period for livestock sold or exchanged on account of drought and your replacement period is scheduled to expire at the end of 2008 (or at the end of the tax year that includes August 31, 2008), see Notice 2008-86. You can find Notice 2008-86 on page 925 of Internal Revenue Bulletin 2008-42 at www.irs.gov/pub/irs-irbs/irb08–42.pdf
. The replacement period will be extended under Notice 2006-82 if the applicable region is on the list included in Notice 2008-86.
If you are a cash basis taxpayer, you realize gain when you receive payments that are more than your basis in the property. If the condemning authority makes deposits with the court, you realize gain when you withdraw (or have the right to withdraw) amounts that are more than your basis.
This applies even if the amounts received are only partial or advance payments and the full award has not yet been determined. A replacement will be too late if you wait for a final determination that does not take place in the applicable replacement period after you first realize gain.
For accrual basis taxpayers, gain (if any) accrues in the earlier year when either of the following occurs.
- All events have occurred that fix the right to the condemnation award and the amount can be determined with reasonable accuracy.
- All or part of the award is actually or constructively received.
For example, if you have an absolute right to a part of a condemnation award when it is deposited with the court, the amount deposited accrues in the year the deposit is made even though the full amount of the award is still contested.
If you buy your replacement property after there is a threat of condemnation but before the actual condemnation and you still hold the replacement property at the time of the condemnation, you have bought your replacement property within the replacement period. Property you acquire before there is a threat of condemnation does not qualify as replacement property acquired within the replacement period. taxmap/pubs/p544-004.htm#en_us_publink100072359
On April 3, 2007, city authorities notified you that your property would be condemned. On June 5, 2007, you acquired property to replace the property to be condemned. You still had the new property when the city took possession of your old property on September 4, 2008. You have made a replacement within the replacement period.taxmap/pubs/p544-004.htm#en_us_publink100072360
You can request an extension of the replacement period from the IRS director for your area. You should apply before the end of the replacement period. Your request should explain in detail why you need an extension. The IRS will consider a request filed within a reasonable time after the replacement period if you can show reasonable cause for the delay. An extension of the replacement period will be granted if you can show reasonable cause for not making the replacement within the regular period.
Ordinarily, requests for extensions are granted near the end of the replacement period or the extended replacement period. Extensions are usually limited to a period of 1 year or less. The high market value or scarcity of replacement property is not a sufficient reason for granting an extension. If your replacement property is being built and you clearly show that the replacement or restoration cannot be made within the replacement period, you will be granted an extension of the period.
Send your request to the address where you filed your return, addressed as follows: taxmap/pubs/p544-004.htm#en_us_publink100072361
Extension Request for Replacement Period of Involuntarily Converted Property
Attention: Area Technical Services, Compliance Function
Report your election to postpone reporting your gain, along with all necessary details, on a statement attached to your return for the tax year in which you realize the gain.
If a partnership or a corporation owns the condemned property, only the partnership or corporation can elect to postpone reporting the gain. taxmap/pubs/p544-004.htm#en_us_publink100072362
If you buy the replacement property after you file your return reporting your election to postpone reporting the gain, attach a statement to your return for the year in which you buy the property. The statement should contain detailed information on the replacement property. taxmap/pubs/p544-004.htm#en_us_publink100072363
If you elect to postpone reporting gain, you must file an amended return for the year of the gain (individuals file Form 1040X) in either of the following situations.
- You do not buy replacement property within the replacement period. On your amended return, you must report the gain and pay any additional tax due.
- The replacement property you buy costs less than the amount realized for the condemned property (minus the gain you excluded from income if the property was your main home). On your amended return, you must report the part of the gain you cannot postpone reporting and pay any additional tax due.
Any deficiency for any tax year in which part of the gain is realized may be assessed at any time before the expiration of 3 years from the date you notify the IRS director for your area that you have replaced, or intend not to replace, the condemned property within the replacement period. taxmap/pubs/p544-004.htm#en_us_publink100072365
You can change your mind about reporting or postponing the gain at any time before the end of the replacement period. taxmap/pubs/p544-004.htm#en_us_publink100072366
Your property was condemned and you had a gain of $5,000. You reported the gain on your return for the year in which you realized it, and paid the tax due. You buy replacement property within the replacement period. You used all but $1,000 of the amount realized from the condemnation to buy the replacement property. You now change your mind and want to postpone reporting the $4,000 of gain equal to the amount you spent for the replacement property. You should file a claim for refund on Form 1040X. Explain on Form 1040X that you previously reported the entire gain from the condemnation, but you now want to report only the part of the gain equal to the condemnation proceeds not spent for replacement property ($1,000).taxmap/pubs/p544-004.htm#en_us_publink100072367
Generally, you report gain or loss from a condemnation on your return for the year you realize the gain or loss.taxmap/pubs/p544-004.htm#en_us_publink100072368
Report gain from a condemnation of property you held for personal use (other than excluded gain from a condemnation of your main home or postponed gain) on Schedule D (Form 1040).
Do not report loss from a condemnation of personal-use property. But, if you received a Form 1099-S, Proceeds From Real Estate Transactions (for example, showing the proceeds of a sale of real estate under threat of condemnation), you must show the transaction on Schedule D (Form 1040) even though the loss is not deductible. Complete columns (a) through (e), and enter -0- in column (f). taxmap/pubs/p544-004.htm#en_us_publink100072369
Report gain (other than postponed gain) or loss from a condemnation of property you held for business or profit on Form 4797. If you had a gain, you may have to report all or part of it as ordinary income. See Like-Kind Exchanges and Involuntary Conversions in chapter 3.