Dear Tax Talk,
Several years ago, my strip mall was "sold" to the county under the process of eminent domain for the purpose of widening a state road. When undergoing this process, I hired a lawyer who strictly deals with eminent domain proceedings. My CPA prepared the corporate tax return based on the sales contract, etc., for the strip mall, and now the Internal Revenue Service is questioning how it was reported.
The IRS claims that personal property such as a hood, chairs and tables that remained in the restaurant as well as outside signage, etc., is subject to sales proceeds, which need to be taxed. The IRS argues that this transaction is treated as a "sale of business." Furthermore, they argue that since the IRS does not have a copy of the appraisal at hand, the assumption is that a certain dollar amount was allocated toward personal property.
This does not make any sense because the valuation and appraisal were done way before the last tenant moved out, so the county wouldn't even know what personal property was left in the building. Also, the county obviously had no interest in the building since the plan was to tear the building down for the road widening. Nobody seems to have a copy of the appraisal other than maybe the lawyer. I have got to believe that there has to be a different tax treatment when a "sale" falls under eminent domain rules. Are forced sales under eminent domain subject to different tax rules?
It sounds like you're dealing with an agent who is trying to make a mountain out of a mole hill.
If I understand, the agent is attempting to allocate part of the proceeds to personal property left by your tenants in order to recharacterize part of the sale proceeds as ordinary income rather than capital gain taxed at a lower rate. While such an allocation is appropriate in the case of the sale of a going concern, in your case the state had no interest in purchasing a business. In fact, the only thing of value to the state was the land.
Therefore, to the buyer, there is no fair market value of those items and therefore, as you point out, there should be no allocation of the proceeds to that property. In fact, I'm sure you could have removed those items if they had any value, but the fact that you chose to abandon that property strengthens your argument that they were without value.
Furthermore, since you were the landlord, the personal property your tenants left behind should have no bearing on your tax consequences. Ordinary income would only come about from depreciation recapture. Since these items were not subject to depreciation in your hands, there would be no ordinary income from their sale.
Your agent is off track, and I would recommend you hire a CPA to represent you on this issue. Alternatively, you could request a conference with the agent's supervisor and present these arguments. If you don't get anywhere with the agent or supervisor, advise them that you will take their findings to IRS appeals.
Ask the adviser
To ask a question on Tax Talk, go to the "Ask the Experts" page and select "Taxes" as the topic. Read more Tax Talk columns.
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.