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Dear Tax Talk,

The city of Tucson (Arizona) is using its power of eminent domain to acquire my home for a road-widening project. Since we could not reach an agreement on a fair price that would be paid to me, I hired an attorney and the matter will now be resolved in court. The court ordered the city to deposit $200,000, and the final sale value will not be determined for another year or so. My current calculation shows that I will have a profit of $70,000, but that amount could possibly change once the court case is settled.

So my questions are:

  • Should I use “involuntary conversion” rules by not reporting the sale on my return for this year’s tax filing?
  • Since it is my primary home, I believe that I do not need to pay tax, as I have been living here 2 out of 5 years and the gain is less than the limit for married couples ($500,000). But again, how do I report it for this year, as the court case will not be settled until next year?

— Han

Dear Han,

You will report the sale in the year the property is sold, which would be when title transfers from you to the city. The city is using its power of eminent domain and the legal process of condemnation whereby your private property is taken for public use without your consent. The IRS considers this an involuntary conversion and there are special provisions in the tax code for these situations.

An involuntary conversion can be the result of property being destroyed because of flooding, tornadoes and other natural disasters or, in other cases, if property is stolen, condemned or disposed of under the threat of condemnation. Generally, you can elect to postpone reporting the gain if you receive money and you buy qualifying replacement property within a certain time period. The details and work sheets regarding the gain postponement are included in IRS Publication 544, Sales and Other Dispositions of Assets, so be sure to read all of the fine print before you proceed.

What is eminent domain?

Eminent domain is the power of the government to take private property and convert it for public use. However, the government must pay a fair compensation to the former owners of the property.

Because this is your home, if you meet the IRS requirements of owning and using the property as your main home for a period totaling 2 years out of the past 5, you may qualify to exclude up to $250,000 of the gain from your income or $500,000 if you file a joint return with your spouse.

There are a lot of nuances to every involuntary conversion. You may want to consider talking to a tax professional who can go over the fine points of your specific situation with you to make sure everything is reported correctly.

Thanks for the great question and all the best to you in working this out.

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