An involuntary conversion occurs when your property is destroyed,
stolen, condemned, or disposed of under the threat of condemnation and
you receive other property or money in payment, such as insurance or a
condemnation award. Involuntary conversions are also called
Gain or loss from an involuntary conversion of your property is
usually recognized for tax purposes unless the property is your main
home. You report the gain or deduct the loss on your tax return for
the year you realize it. (You cannot deduct a loss from an involuntary
conversion of property you held for personal use unless the loss
resulted from a casualty or theft.)
However, depending on the type of property you receive, you may not
have to report a gain on an involuntary conversion. You do not report
the gain if you receive property that is similar or related in service
or use to the converted property. Your basis for the new property is
the same as your basis for the converted property. The gain on the
involuntary conversion is deferred until a taxable sale or exchange
If you receive money or property that is not similar or related in
service or use to the involuntarily converted property and you buy
qualifying replacement property within a certain period of time, you
can choose to postpone reporting the gain.
This publication explains the treatment of a gain or loss from a
condemnation or disposition under the threat of condemnation. If you
have a gain or loss from the destruction or theft of property, see
A condemnation is the process by which private property is legally
taken for public use without the owner's consent. The property may be
taken by the federal government, a state government, a political
subdivision, or a private organization that has the power to legally
take it. The owner receives a condemnation award (money or property)
in exchange for the property taken. A condemnation is like a forced
sale, the owner being the seller and the condemning authority being
A local government authorized to acquire land for public parks
informed you that it wished to acquire your property. After the local
government took action to condemn your property, you went to court to
keep it. But the court decided in favor of the local government, which
took your property and paid you an amount fixed by the court. This is
a condemnation of private property for public use.
Threat of condemnation.
A threat of condemnation exists if a representative of a government
body or a public official authorized to acquire property for public
use informs you that the government body or official has decided to
acquire your property. You must have reasonable grounds to believe
that, if you do not sell voluntarily, your property will be condemned.
The sale of your property to someone other than the condemning
authority qualifies as an involuntary conversion, provided you have
reasonable grounds to believe that your property will be condemned. If
the buyer of this property knows at the time of purchase that it will
be condemned and sells it to the condemning authority, this sale also
qualifies as an involuntary conversion.
Reports of condemnation.
A threat of condemnation exists if you learn of a decision to
acquire your property for public use through a report in a newspaper
or other news medium, and this report is confirmed by a representative
of the government body or public official involved. You must have
reasonable grounds to believe that they will take necessary steps to
condemn your property if you do not sell voluntarily. If you relied on
oral statements made by a government representative or public
official, the Internal Revenue Service may ask you to get written
confirmation of the statements.
Your property lies along public utility lines. The utility company
has the authority to condemn your property. The company informs you
that it intends to acquire your property by negotiation or
condemnation. A threat of condemnation exists when you receive the
Related property voluntarily sold.
A voluntary sale of your property may be treated as a forced sale
that qualifies as an involuntary conversion if the property had a
substantial economic relationship to property of yours that was
condemned. A substantial economic relationship exists if
together the properties were one economic unit. You must also show
that the condemned property could not reasonably or adequately be
replaced. You can choose to postpone reporting the gain by buying
replacement property. See Postponement of Gain, later.
Gain or Loss
If your property was condemned or disposed of under the threat of
condemnation, figure your gain or loss by comparing the adjusted basis
of your condemned property with your net condemnation award.
If your net condemnation award is more than the adjusted basis of
the condemned property, you have a gain. You can postpone reporting
gain from a condemnation if you buy replacement property. If only part
of your property is condemned, you can treat the cost of restoring the
remaining part to its former usefulness as the cost of replacement
property. See Postponement of Gain, later.
If your net condemnation award is less than your adjusted basis,
you have a loss. If your loss is from property you held for personal
use, you cannot deduct it. You must report any deductible loss in the
tax year it happened.
You can use Part 2 of Table 1-3 to figure your
gain or loss from a condemnation award.
Main home condemned.
If you have a gain because your main home is condemned, you
generally can exclude the gain from your income as if you had sold or
exchanged your home. You may be able to exclude up to $250,000 of the
gain (up to $500,000 if married filing jointly). For information on
this exclusion, see Publication 523.
If your gain is more than you can
exclude but you buy replacement property, you may be able to postpone
reporting the rest of the gain. See Postponement of Gain,
A condemnation award is the money you are paid or the value of
other property you receive for your condemned property. The award is
also the amount you are paid for the sale of your property under
threat of condemnation.
Payment of your debts.
Amounts taken out of the award to pay your debts are considered
paid to you. Amounts the government pays directly to the holder of a
mortgage or lien against your property are part of your award, even if
the debt attaches to the property and is not your personal liability.
The state condemned your property for public use. The award was set
at $200,000. The state paid you only $148,000 because it paid $50,000
to your mortgage holder and $2,000 accrued real estate taxes. You are
considered to have received the entire $200,000 as a condemnation
Interest on award.
If the condemning authority pays you interest for its delay in
paying your award, it is not part of the condemnation award. You must
report the interest separately as ordinary income.
Payments to relocate.
Payments you receive to relocate and replace housing because you
have been displaced from your home, business, or farm as a result of
federal or federally assisted programs are not part of the
condemnation award. Do not include them in your income. Replacement
housing payments used to buy new property are included in the
property's basis as part of your cost.
Net condemnation award.
A net condemnation award is the total award you received, or are
considered to have received, for the condemned property minus your
expenses of obtaining the award. If only a part of your property was
condemned, you must also reduce the award by any special assessment
levied against the part of the property you retain. This is discussed
later under Special assessment taken out of award.
Severance damages are not part of the award paid for the property
condemned. They are paid to you if part of your property is condemned
and the value of the part you keep is decreased because of the
For example, you may receive severance damages if your property is
subject to flooding because you sell flowage easement rights (the
condemned property) under threat of condemnation. Severance damages
may also be given to you if, because part of your property is
condemned for a highway, you must replace fences, dig new wells or
ditches, or plant trees to restore your remaining property to the same
usefulness it had before the condemnation.
The contracting parties should agree on the severance damages and
put that in writing. If this is not done, all proceeds from the
condemning authority are considered awarded for your condemned
You cannot make a completely new allocation of the total award
after the transaction is completed. However, you can show how much of
the award both parties intended for severance damages. The severance
damages part of the award is determined from all the facts and
You sold part of your property to the state under threat of
condemnation. The contract you and the condemning authority signed
showed only the total purchase price. It did not specify a fixed sum
for severance damages. However, at settlement, the condemning
authority gave you closing papers showing clearly the part of the
purchase price that was for severance damages. You may treat this part
as severance damages.
Treatment of severance damages.
Your net severance damages are treated as the amount realized from
an involuntary conversion of the remaining part of your property. Use
them to reduce the basis of the remaining property. If the amount of
severance damages is based on damage to a specific part of the
property you kept, reduce the basis of only that part by the net
If your net severance damages are more than the basis of your
retained property, you have a gain. You may be able to postpone
reporting the gain. See Postponement of Gain, later.
You can use Part 1 of Table 1-3 to figure any gain
from severance damages and to refigure the adjusted basis of the
remaining part of your property.
Net severance damages.
To figure your net severance damages, you must first reduce your
severance damages by your expenses in obtaining the damages. You then
reduce them by any special assessment (described later) levied against
the remaining part of the property and taken out of the award by the
condemning authority. The balance is your net severance damages.
Expenses of obtaining a condemnation award and severance
Subtract the expenses of obtaining a condemnation award, such as
legal, engineering, and appraisal fees, from the total award. Also
subtract the expenses of obtaining severance damages, which may
include similar expenses, from the severance damages paid to you. If
you cannot determine which part of your expenses is for each part of
the condemnation proceeds, you must make a proportionate allocation.
You receive a condemnation award and severance damages. One-fourth
of the total was designated as severance damages in your agreement
with the condemning authority. You had legal expenses for the entire
condemnation proceeding. You cannot determine how much of your legal
expenses is for each part of the condemnation proceeds. You must
allocate one-fourth of your legal expenses to the severance damages
and the other three-fourths to the condemnation award.
Special assessment taken out of award.
When only part of your property is condemned, a special assessment
levied against the remaining property may be taken out of your
condemnation award. An assessment may be levied if the remaining part
of your property benefited by the improvement resulting from the
condemnation. Examples of improvements that may cause a special
assessment are widening a street and installing a sewer.
To figure your net condemnation award, you generally reduce the
award by the assessment taken out of the award.
To widen the street in front of your home, the city condemned a
25-foot deep strip of your land. You were awarded $5,000 for this and
spent $300 to get the award. Before paying the award, the city levied
a special assessment of $700 for the street improvement against your
remaining property. The city then paid you only $4,300. Your net award
is $4,000 ($5,000 total award minus $300 expenses in obtaining the
award and $700 for the special assessment taken out).
If the $700 special assessment were not taken out of the award and
you were paid $5,000, your net award would be $4,700 ($5,000 -
$300). The net award would not change, even if you later paid the
assessment from the amount you received.
Severance damages received.
If severance damages are included in the condemnation proceeds, the
special assessment taken out is first used to reduce the severance
damages. Any balance of the special assessment is used to reduce the
You were awarded $4,000 for the condemnation of your property and
$1,000 for severance damages. You spent $300 to obtain the severance
damages. A special assessment of $800 was taken out of the award. The
$1,000 severance damages are reduced to zero by first subtracting the
$300 expenses and then $700 of the special assessment. Your $4,000
condemnation award is reduced by the $100 balance of the special
assessment, leaving a $3,900 net condemnation award.
Part business or rental.
If you used part of your condemned property as your home and part
as business or rental property, treat each part as a separate
property. Figure your gain or loss separately, because gain or loss on
each part may be treated differently.
Some examples of this type of property are a building in which you
live and operate a grocery, and a building in which you live on the
first floor and rent out the second floor.
You sold your building for $24,000 under threat of condemnation to
a public utility company that had the authority to condemn. You rented
half the building and lived in the other half. You paid $25,000 for
the building and spent an additional $1,000 for a new roof. You
claimed allowable depreciation of $4,600 on the rental half. You spent
$200 in legal expenses to obtain the condemnation award. Figure your
gain or loss as follows.
||Condemnation award re-
||Minus: Legal expenses, $200
||Net condemnation award
|| Adjusted basis:|
||1/2 of original cost,
$25,000 Plus: 1/2 of cost of roof,
||Adjusted basis, business part
||Loss on residential
||Gain on business
|The loss on the
residential part of the property is not
Postponement of Gain
Do not report the gain on condemned property if you receive only
property that is similar or related in service or use to the condemned
property. Your basis for the new property is the same as your basis
for the old.
You must ordinarily report the gain if you receive money or unlike
property. You can choose to postpone reporting the gain if you buy
property that is similar or related in service or use to the condemned
property within the replacement period, discussed later. You can also
choose to postpone reporting the gain if you buy a controlling
interest (at least 80%) in a corporation owning property that is
similar or related in service or use to the condemned property. See
Controlling interest in a corporation, later.
To postpone reporting all the gain, you must buy replacement
property costing at least as much as the amount realized for the
condemned property. If the cost of the replacement property is less
than the amount realized, you must report the gain up to the unspent
part of the amount realized.
You can use Part 3 of Table 1-3 to figure the gain
you must report and your postponed gain.
Reduce the basis of the replacement property by the postponed gain.
Also, if your replacement property is stock in a corporation that owns
property similar or related in service or use, the corporation will
generally reduce its basis in its assets by the amount by which you
reduce your basis in the stock. See Controlling interest in a
Postponing gain on severance damages.
If you received severance damages for part of your property because
another part was condemned and you buy replacement property, you can
choose to postpone reporting gain. See Treatment of severance
damages, earlier. You can postpone reporting all your gain if
the replacement property costs at least as much as your net severance
damages plus your net condemnation award (if resulting in gain).
You can also make this choice if you spend the severance damages,
together with other money you received for the condemned property (if
resulting in gain), to acquire nearby property that will allow you to
continue your business. If suitable nearby property is not available
and you are forced to sell the remaining property and relocate in
order to continue your business, see Postponing gain on the sale
of related property, next.
If you restore the remaining property to its former usefulness, you
can treat the cost of restoring it as the cost of replacement
Postponing gain on the sale of related property.
If part of your property is condemned and you sell the related part
and buy replacement property, you can choose to postpone reporting
gain on the sale. You must meet the requirements explained earlier
under Related property voluntarily sold. You can postpone
reporting all your gain if the replacement property costs at least as
much as the amount realized from the sale plus your net condemnation
award (if resulting in gain) plus your net severance damages, if any
(if resulting in gain).
Buying replacement property from a related person.
Certain taxpayers cannot postpone reporting gain from a
condemnation if they buy the replacement property from a related
person. For information on related persons, see Nondeductible
Loss under Sales and Exchanges Between Related Persons
in chapter 2.
This rule applies to the following taxpayers.
- C corporations.
- Partnerships in which more than 50% of the capital or
profits interest is owned by C corporations.
- All others (including individuals, partnerships (other than
those in (2), and S corporations) if the total realized gain for the
tax year on all involuntarily converted properties on which there are
realized gains is more than $100,000.
For taxpayers described in (3) above, gains cannot be offset with
any losses when determining whether the total gain is more than
$100,000. If the property is owned by a partnership, the $100,000
limit applies to the partnership and each partner. If the property is
owned by an S corporation, the $100,000 limit applies to the S
corporation and each shareholder.
This rule does not apply if the related person acquired the
property from an unrelated person within the replacement period.
If you pay a contractor in advance to build your replacement
property, you have not bought replacement property unless it is
finished before the end of the replacement period (discussed later).
To postpone reporting gain, you must buy replacement property for
the specific purpose of replacing your condemned property. You do not
have to use the actual funds from the condemnation award to acquire
the replacement property. Property you acquire by gift or inheritance
does not qualify as replacement property.
Similar or related in service or use.
Your replacement property must be similar or related in service or
use to the property it replaces.
If the condemned property is real property you held for use in your
trade or business or for investment (other than property held mainly
for sale) but your replacement property is not similar or related in
service or use, it will be treated as such if it is like-kind property
to be held for use in a trade or business or for investment. For a
discussion of like-kind property, see Like-Kind Property
under Like-Kind Exchanges, later.
If you are an owner-user, similar or related in service or use
means that replacement property must function in the same way as the
property it replaces.
Your home was condemned and you invested the proceeds from the
condemnation in a grocery store. Your replacement property is not
similar or related in service or use to the condemned property. To be
similar or related in service or use, your replacement property must
also be used by you as your home.
If you are an owner-investor, similar or related in service or use
means that any replacement property must have the same relationship of
services or uses to you as the property it replaces. You decide this
by determining all the following information.
- Whether the properties are of similar service to you.
- The nature of the business risks connected with the
- What the properties demand of you in the way of management,
service, and relations to your tenants.
You owned land and a building you rented to a manufacturing
company. The building was condemned. During the replacement period,
you had a new building built on other land you already owned. You
rented out the new building for use as a wholesale grocery warehouse.
Because the replacement property is also rental property, the two
properties are considered similar or related in service or use if
there is a similarity in all the following areas.
- Your management activities.
- The amount and kind of services you provide to your
- The nature of your business risks connected with the
Leasehold replaced with fee simple property.
Fee simple property you will use in your trade or business or for
investment can qualify as replacement property that is similar or
related in service or use to a condemned leasehold if you use it in
the same business and for the identical purpose as the condemned
leasehold. If the condemned leasehold has 30 or more years to run, the
fee simple property is like-kind property.
A fee simple property interest generally is a property
interest that entitles the owner to the entire property with
unconditional power to dispose of it during his or her lifetime. A
leasehold is property held under a lease, usually for a
term of years.
Outdoor advertising display replaced with real property.
You can choose to treat an outdoor advertising display as real
property. If you make this choice and you replace the display with
real property in which you hold a different kind of interest, your
replacement property can qualify as like-kind property. For example,
real property bought to replace a destroyed billboard and leased
property on which the billboard was located qualifies as property of a
You can make this choice only if you did not claim a section 179
deduction for the display. You cannot cancel this choice unless you
get the consent of the Internal Revenue Service.
An outdoor advertising display is a sign or device rigidly
assembled and permanently attached to the ground, a building, or any
other permanent structure used for commercial or other advertisement
to the public.
Substituting replacement property.
Once you designate certain property as replacement property on your
tax return, you cannot substitute other qualified property. But if
your previously designated replacement property does not qualify, you
can substitute qualified property if you acquire it within the
Controlling interest in a corporation.
You can replace property by acquiring a controlling interest in a
corporation that owns property similar or related in service or use to
your condemned property. You have controlling interest if you own
stock having at least 80% of the combined voting power of all classes
of voting stock and at least 80% of the total number of shares of all
other classes of stock.
Basis adjustment to corporation's property.
The basis of property held by the corporation at the time you
acquired control must be reduced by your postponed gain, if any. You
are not required to reduce the adjusted bases of the corporation's
properties below your adjusted basis in the corporation's stock
(determined after reduction by your postponed gain).
Allocate this reduction to the following classes of property in the
order shown below.
- Property that is similar or related in service or use to the
- Depreciable property not reduced in (1).
- All other property.
If two or more properties fall in the same class, allocate the
reduction to each property in proportion to the adjusted bases of all
the properties in that class. The reduced basis of any single property
cannot be less than zero.
Main home replaced.
If your gain from a condemnation of your main home is more than you
can exclude from your income (see Main home condemned under
Gain or Loss From Condemnations, earlier), you can postpone
reporting the rest of the gain by buying replacement property that is
similar or related in service or use. To postpone reporting all the
gain, the replacement property must cost at least as much as the
amount realized from the condemnation minus the excluded gain.
You must reduce the basis of your replacement property by the
postponed gain. Also, if you postpone reporting any part of your gain
under these rules, you are treated as having owned and used the
replacement property as your main home for the period you owned and
used the condemned property as your main home.
To postpone reporting your gain from a condemnation, you must buy
replacement property within a certain period of time. This is the
The replacement period for a condemnation begins on the earlier of
the following dates.
- The date on which you disposed of the condemned
- The date on which the threat of condemnation began.
The replacement period ends 2 years after the end of the first tax
year in which any part of the gain on the condemnation is realized.
If real property held for use in a trade or business or for
investment (not including property held primarily for sale) is
condemned, the replacement period ends 3 years after the end of the
first tax year in which any part of the gain on the condemnation is
realized. However, this 3-year replacement period cannot be used if
you replace the condemned property by acquiring control of a
corporation owning property that is similar or related in service or
Determining when gain is realized.
If you are a cash basis taxpayer, you realize gain when you receive
payments that are more than your basis in the property. If the
condemning authority makes deposits with the court, you realize gain
when you withdraw (or have the right to withdraw) amounts that are
more than your basis.
This applies even if the amounts received are only partial or
advance payments and the full award has not yet been determined. A
replacement will be too late if you wait for a final determination
that does not take place in the applicable replacement period after
you first realize gain.
For accrual basis taxpayers, gain (if any) accrues in the earlier
year when either of the following occurs.
- All events have occurred that fix the right to the
condemnation award and the amount can be determined with reasonable
- All or part of the award is actually or constructively
For example, if you have an absolute right to a part of a
condemnation award when it is deposited with the court, the amount
deposited accrues in the year the deposit is made even though the full
amount of the award is still contested.
Replacement property bought before the condemnation.
If you buy your replacement property after there is a threat of
condemnation but before the actual condemnation and you still hold the
replacement property at the time of the condemnation, you have bought
your replacement property within the replacement period. Property you
acquire before there is a threat of condemnation does not qualify as
replacement property acquired within the replacement period.
On April 3, 2000, city authorities notified you that your property
would be condemned. On June 5, 2000, you acquired property to replace
the property to be condemned. You still had the new property when the
city took possession of your old property on September 4, 2001. You
have made a replacement within the replacement period.
You can get an extension of the replacement period if you apply to
the IRS director for your area. You should apply before the end of the
replacement period. Your application should contain all details of
your need for an extension. You can file an application within a
reasonable time after the replacement period ends if you can show
reasonable cause for the delay. An extension of the replacement period
will be granted if you can show reasonable cause for not making the
replacement within the regular period.
Ordinarily, requests for extensions are granted near the end of the
replacement period or the extended replacement period. Extensions are
usually limited to a period of 1 year or less. The high market value
or scarcity of replacement property is not a sufficient reason for
granting an extension. If your replacement property is being built and
you clearly show that the replacement or restoration cannot be made
within the replacement period, you will be granted an extension of the
Choosing to postpone gain.
Report your choice to postpone reporting your gain, along with all
necessary details, on a statement attached to your return for the tax
year in which you realize the gain.
If a partnership or a corporation owns the condemned property,
only the partnership or corporation can choose to postpone
reporting the gain.
Replacement property acquired after return filed.
If you buy the replacement property after you file your return
reporting your choice to postpone reporting the gain, attach a
statement to your return for the year in which you buy the property.
The statement should contain detailed information on the replacement
If you choose to postpone reporting gain, you must file an amended
return for the year of the gain (individuals file Form 1040X) in
either of the following situations.
- You do not buy replacement property within the replacement
period. On your amended return, you must report the gain and pay any
additional tax due.
- The replacement property you buy costs less than the amount
realized for the condemned property (minus the gain you excluded from
income if the property was your main home). On your amended return,
you must report the part of the gain you cannot postpone reporting and
pay any additional tax due.
Time for assessing a deficiency.
Any deficiency for any tax year in which part of the gain is
realized may be assessed at any time before the expiration of 3 years
from the date you notify the IRS director for your area that you have
replaced, or intend not to replace, the condemned property within the
Changing your mind.
You can change your mind about reporting or postponing the gain at
any time before the end of the replacement period.
Your property was condemned and you had a gain of $5,000. You
reported the gain on your return for the year in which you realized
it, and paid the tax due. You buy replacement property within the
replacement period. You used all but $1,000 of the amount realized
from the condemnation to buy the replacement property. You now change
your mind and want to postpone reporting the $4,000 of gain equal to
the amount you spent for the replacement property. You should file a
claim for refund on Form 1040X. Explain on Form 1040X that you
previously reported the entire gain from the condemnation, but you now
want to report only the part of the gain equal to the condemnation
proceeds not spent for replacement property ($1,000).
Reporting a Condemnation
Gain or Loss
Generally, you report gain or loss from a condemnation on your
return for the year you realize the gain or loss.
Report gain from a condemnation of property you held for personal
use (other than excluded gain from a condemnation of your main home or
postponed gain) on Schedule D (Form 1040).
Do not report loss from a condemnation of personal-use property.
But if you received a Form 1099-S, Proceeds From Real
Estate Transactions (for example, showing the proceeds of a sale
of real estate under threat of condemnation), you must show the
transaction on Schedule D even though the loss is not deductible.
Complete columns (a) through (e), and enter -0- in column (f).
Report gain (other than postponed gain) or loss from a condemnation
of property you held for business or profit on Form
4797. If you had a gain, you may
have to report all or part of it as ordinary income. See
Like-Kind Exchanges and Involuntary Conversions in chapter