How Does the IRS Treat Easement Payments?

Mar 23rd 2017
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The tax rules can be confusing when a landowner gets paid for granting an easement, legal lingo for the right for something or someone to have access to or use of a portion of the property. The tax result depends upon whether an easement for, say, utilities affects all of the property or only a specific part of it.

When only a specific part is affected, the measurement of the owner’s gain is the difference between the payment received for the sale of an easement and the basis (usually cost) of the property allocated to that part.

Suppose, though, that no allocation is necessary because the entire property is affected or it’s impossible or impractical to make an allocation due to the nature of the easement or of the property. Then the sales proceeds simply reduce the total basis of the property. The owner has to count the gain as reportable income only if the proceeds run to more than the full cost of what he or she paid for the property.

The courts often have to resolve the factual issue of whether an easement affects all or part of the property. Consider, for example, what happened when David Fasken, the owner of a 165,000-acre ranch, received $18,000 for granting easements for pipelines, towers, etc., on his land, plus rights of ingress and egress.

According to David’s calculations, he owed no taxes on the $18,000 because it merely reduced the total basis of his ranch. The IRS, however, contended that only 32 acres were affected, not the entire ranch. Because the basis for these 32 acres was $300, he realized a capital gain of $17,700.

The IRS was backed up the US Tax Court. It refused to offset the $18,000 by the entire cost of the ranch.

The law authorizes an exception: The gain may qualify for deferral under special rules for involuntary conversions where the proceeds are used to acquire similar property.

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