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The IRS is Pro-Taxpayer for Certain Property Condemnations

Sep 3rd 2019
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In several previous columns, I’ve discussed Internal Revenue Code Section 1033. It authorizes a valuable break when property is condemned (“involuntarily converted”) by a governmental authority or sold to it under treat of condemnation. The owner of property lost through condemnation can elect to defer tax on the gain to the extent that the owner reinvests the proceeds in similar property.

I devote this column to two related Revenue Rulings, 81-80 and 81-181. They show the agency’s willingness to take pro-taxpayer approaches on when condemnations pass muster under Section 1033.

81-180 determines that a sale of land under threat of condemnation satisfies the requisites for Section 1033, notwithstanding that the taxpayer knows at the time she acquires the property that a local government agency is going to authorize its condemnation.

81-181 determines that a land sale similarly qualifies, although the sale is made to a person other than the condemning authority. What follows are the two scenarios.

In the first of the rulings, Norma Bates reads in the paper that her 40 acres will be condemned for a city park. Norma’s confirmation comes from a city official that the newspaper account isn’t fake news.

She then sells the property to Clarice Lecter, an unrelated third party who isn’t acting as an agent for or in cooperation with the condemning authority. Before Clarice buys the property, she obtains a similar confirmation from a city official. Clarice then arranges to sell the land to the city.

The IRS uses 81-180 and 81-181to resolve two issues. The first one: Whether Section 1033 requires that property sold under threat of condemnation has to be sold to the condemning authority or to one acting as an agent for or in cooperation with the condemning authority. It doesn’t.

The second one: Whether Section 1033 imposes a requirement the property’s acquirer be unaware of the condemnation threat. It doesn’t.

Consequently, concludes the IRS, both Norma’s sale to Clarice and Clarice’s to the city qualify under Section 1033. What if Norma and Clarice each reinvest the proceeds from her sale in similar property? The gain realized by each of them will be eligible for deferral.

IRS Publication 544, “Sales and Other Dispositions of Assets,” offers much more on involuntary conversion, and is available at irs.gov.

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 300 and counting). 

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