What is Eminent Domain?
Government, whatever level, has the right to seize a private property for public purposes in return for just compensation. For this article, we will set aside this issue of what constitutes public use and ‘just’ compensation. Even the Supreme Court is not in consensus over what these terms should mean. So, this article addresses the repercussions of being compensated for land condemned by the government. Specifically, despite the government takes your land without your consent for their own purposes, you are nonetheless expected to pay taxes for the compensation you receive.
Why You Pay Taxes on the Compensation
The government may be taking your land involuntarily. However, they give you compensation that is at least the fair market value of your property at the time of the taking. Regardless of how you are paid, the government treats the conveyance of land as if your sold it to any other buyer. Therefore, you are expected to pay the appropriate taxes on the revenue. Essentially, the government taxes your income regardless of from where it comes. This is why eminent domain compensation is taxed.
What You Should Do When Facing Eminent Domain
If you are facing having property taken by the government, meet with a lawyer or a CPA, if not both. They will review the taxable gain of the property. Taxable gain is the “amount by which the sale price exceeds the tax basis of the property.” The tax basis is calculated by the price at which the property was originally bought. If it has been a great number of years since then, the value of the taken property may have increased substantially, and that will be reflected in the taxable gain. That is not all. Not only may the compensation be taxed, but if there are any debtors or liens claimed against the land, they will be repaid by the money from the compensation, leaving you with even less. This is why we recommend consulting an attorney or CPA in the midst of eminent domain to best understand the financial situation in which you could find yourself following the condemnation of your property.
What Part of Eminent Domain is Taxable?
The amount of tax owed is based on the value collected over the years of owning the property. For example, if you bought real estate for $150,000 but is not worth $200,000, it is like you earning $50,000. Thus, the $50,000 received from compensation is taxed as taxable gain.
What Remains Protected
When the government decides private land is needed, it is not authorized to take more property than is proven necessary to fulfill its project.
Furthermore, taxation may be avoidable in some cases. Depending on your jurisdiction, if you used the proceeds of eminent domain to purchase a different property in a certain amount of time, the taxable gain may be avoided. It is recommended that you seek legal help from a lawyer or tax expert in this area if you wish to avoid taxation on the eminent domain proceeds from the government.