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Taxes on an eminent domain property seizure

 

Dear Tax Talk,
I have property that is going to be sold to the state of California due to Freeway 125 in the San Diego area. They offered $57,000. What would be the best way to avoid paying high taxes on that money? How should I invest it? Thank you for your reply. -- Dean

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Dear Dean,
When the state takes your property under eminent domain, the property is treated as involuntarily converted. You can elect to replace involuntarily converted property with similar property and avoid paying tax on the gain. It's kind of the same rules that apply to like-kind exchanges, but you're given additional time to replace the property.

If you don't elect to defer the gain, then you would pay tax on the gain as you normally would. For most taxpayers, that would most likely be long-term capital gains taxed at 15 percent federal and the filer's prevailing state rate.

First, the state has to be threatening to take the property if you don't voluntarily sell it to them. This is generally the case when the state takes property for public use such as for a freeway.

Secondly, you have to replace the condemned property by the end of the second tax year following when you dispose of the property. For example, if you sell the property in 2003, you have until Dec. 31, 2005, to replace the property without recognizing gain.

You have to invest the entire net proceeds in order to avoid the gain. For example, if you receive the full $57,000, you have to purchase replacement property costing more than this. You can make several acquisitions that add up to the net amount received.

You make the election to apply the involuntary conversion rules by not reporting the sale on your return. However, you should attach a statement to your return showing the particulars of the sale and the resulting gain and indicating that you intend the rules of Section 1033 (like-kind exchange) apply to the conversion. If you don't replace the property in the time allowed, you must amend your return for the year of the gain and pay the back taxes and interest.

 

 
-- Posted: Sept. 26, 2003
   

 

 
 

 

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