Eminent Domain: General Tax Principles

Eminent Domain: General Tax Principles

1) Income Tax

You may have heard of “1031 deferred exchanges.”  In eminent domain situations, impacted property owners are given the right to do an easier and more beneficial “1033 deferred exchange.”  Under Internal Revenue Code 1033, in eminent domain situations you can defer payment of capital gains taxes if you replace the property taken in or threatened by eminent domain with “like kind” property.  You have three years to replace investment property or property devoted to a trade or business.  You have two years to replace all other property.  Please consult your own tax adviser to determine which period applies and to determine what constitutes “like kind” property.  The replacement period begins to run from when you “realize a gain.”  If, in an eminent domain taking, you paid less for the property taken than the amount of compensation you receive, you may be “realizing a gain.”  You may also “realize a gain” if you withdraw the government’s deposit of probable compensation in your eminent domain case and the amount you withdraw is more than you paid for the property.   Again, check with your own tax adviser to confirm whether and when you “realize a gain.”

2) Property Tax

Under California law, you may also be able to transfer your property tax basis to the replacement property.  It is easiest to do this if the replacement is in the same county; though it is possible to do it to a different county in California.  However, you will probably NOT be able to transfer property tax basis if the replacement is out of state.  Check with your CPA or tax adviser.  Typically, the websites for the assessors in California counties have identical or similar forms you can download to transfer property tax basis.  Use the one in the county where the replacement property is located.

3) Goodwill Loss or Damage

A business usually has two parts to its value—an intangible part and a tangible part. The tangible part is the value of everything that you can “touch” or quantify easily—the inventory, the leased building, the accounts receivable, the equipment, etc. Some businesses have an extra intangible value, however, that is over and in addition to the tangible value. Because they have been in place and profitable, have a good location and established clientele, and are already set up and ready to go, a knowing buyer would pay more for these businesses because of this additional intangible. That intangible is goodwill.  Under California law (but not federal law and the law of several other states), a business impacted by eminent domain may be able to recover for loss of or damage to its business goodwill.  Generally, such recovery for the lost or damaged goodwill value (if it does not exceed basis) is not taxable at all. It is simply a return of the capital of the business, to make it whole again. If the recovery exceeds the basis, however, the recovery in excess of the basis may be taxable as capital gain. That taxable gain might be deferrable under Internal Revenue Code 1033 if “like kind” replacement property is acquired as discussed in No. 1 above. Furthermore, if the goodwill recovery is really a disguised recovery of loss of profits, rather than loss of goodwill value, the recovery may be taxable as ordinary income not capital gain.  It is important to address the tax treatment of any possible goodwill recovery as early as possible with your tax advisers so that you are set up to obtain as favorable treatment as possible in light of these issues.

3) Relocation Benefits

Relocation benefit payments are not considered “income” under California Government Code 7269.  Check with your CPA/tax advisor regarding how these payments will be treated under federal law.

4) Always Check with Your CPA or Tax Advisor

These are general principles.  However, the actual tax treatment of your recovery depends on things that only your CPA or tax adviser can know—for example, the basis, how long the asset has been held, how it has been treated previously, whether it can be replaced with “like kind” property, and so on. This is why you MUST understand that, even though you have the above general tax information, you still need to have your tax advisers apply these general principles to your specific tax situation. You need to have someone look at these issues, in the context of your overall tax situation, so that they are dealt with as part of the whole picture. Your rights depend on the facts of your specific tax situation.  These general principles may not apply to your specific situation.  Also, tax law changes.  Make sure you have your tax adviser or CPA update these general principles to capture any changes that may have occurred in the law.

Our attorneys have over 50 years combined experience in representing property and business owners impacted by eminent domain. Schedule a free intial consultation today.

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