When the government exercises eminent domain, property owners are entitled to receive compensation for the property that’s ultimately taken. This “condemnation compensation” is usually based on the property’s fair market value.
While dealing with the loss of one’s property is hard enough, you may also find yourself dealing with an unexpected tax bill that’s related to the compensation you’re given.
Condemnation compensation can be taxable
Exactly how the condemnation compensation is taxable depends on several different things, including whether the property was your primary residence, a business or investment property.
Some of the issues that might come up include capital gains taxes. If the compensation you receive exceeds your property’s adjusted basis (the price you paid for it plus the cost of home improvements), you can owe short-term or long-term capital gains taxes. For example, if you purchased land for $100,000 and received $200,000 from the government after it was condemned for eminent domain, you could owe capital gains taxes on the $100,000 profit. If the condemned property was your primary residence, however, you may qualify for a capital gains exclusion based on the amount of the compensation, your marital and tax-filing status and the length of time you had been in residence.
If your property was used for a business or investments, you may be in a similar fix with capital gains – unless you can defer the capital gains taxes by reinvesting the condemnation proceeds into a “like-kind” property within a specified time.
Because there are so many variables involved, taxation issues should absolutely be a part of the discussions you have when you’re negotiating for fair compensation. Legal guidance is essential.