Eminent Domain: Do I Have to Pay Taxes if My Land is Taken?

The answer to this question is complex. If you have had your North Carolina land taken through an eminent domain proceeding, there has been a "taxable event" according to both the federal Internal Revenue Service ("IRS") and North Carolina taxing authorities. In simple terms, taxing authorities consider a taking of land to be equivalent to a sale of land for tax purposes. However, a "taxable event" does not automatically mean that taxes are owed. So, whether you -- as the landowner -- will actually have a tax liability to pay after your land is taken depends on several factors.

First, there must have been a financial gain realized from the taking of the land. "Financial gain" can be thought of as "profit." When a government -- or private third party -- uses the power of eminent domain to take private land, the government must pay "just compensation" for the land. If the amount paid in "just compensation" is not more than what the landowner originally paid, then there is no taxable gain. For example, if the landowner originally paid $50,000 for the property and only received $50,000 from the government as just compensation, then there is no gain. As such, there would be no tax liability even though a "taxable event" occurred. In tax terms, the original price paid is called the "tax basis in the property." Over the years, the tax basis for a property may go up or down depending on whether capital improvements have been made and whether depreciation has been taken.

Second, under federal tax laws, if the land in question was the taxpayer's home, there are exemptions that might be available to avoid a tax liability.

Third, under federal tax laws, there are methods of avoiding taxes through property replacement procedures. The mechanisms are complicated and involve what the IRS calls "nonrecognition of gains." In very simple terms, when land is taken through eminent domain, the IRS will permit nonrecognition of gains if the landowner uses the entire "just compensation" to buy an eligible "replacement" property within an allowable amount of time (usually two to three years). As noted, the process is complicated with many specific and detailed rules that must be followed strictly. Landowners seeking to avoid tax liabilities through this mechanism will need to obtain advice from qualified tax professionals.

Other issues with respect to taxable gains include:

• Whether the property was used for rental purposes
• Any depreciation previously taken
• Capital improvements
• Previous nonrecognition of gains events
• And more

The discussion above assumed that the eminent domain proceedings resulted in a taking of the entire land in question. However, sometimes, the government will use eminent domain to only take a portion of a person's land. This is generally called a "partial taking." For example, to widen a road or highway, the North Carolina Department of Transportation might take a 20-foot strip of an owner's property that runs along the road.

Again, the tax consequences of a partial taking are very complicated, and landowners will need to obtain advice from qualified tax professionals. Generally, there are two issues:

• Whether taxes must be paid on the just compensation paid for the land actually taken and
• The tax consequences for any loss in value to the remaining land that was not taken

With the first issue, there may be tax liability depending on the property basis and other factors. Taxing authorities generally consider this aspect of a partial taking as similar to a landowner subdividing a parcel and selling a sub portion.

With respect to the second issue -- often called just compensation for "severance damages" -- tax liability is often deferred assuming that the landowner can properly document the severance damages. Essentially, the amount allocated to severance damages is applied to reduce the property’s tax basis. For example, if the original price paid for the land was $50,000 and $10,000 was paid for severance damages, the new tax basis for the land would be $40,000. In this way, the tax consequences are deferred to that point in time when the landowner sells the land. In theory, the future sales price reflects the fact that the land has lost value because of the partial taking. Thus, for example, if, in the future, the land is sold for $40,000, then there would be no taxable gain and there would be no tax liability. The situation would be different, of course, if the severance damages that were paid exceeded the property’s tax basis.

For more information, and to schedule a confidential consultation with experienced and dedicated eminent domain and condemnation attorneys in Charlotte, contact Arnold & Smith, PLLC. Use our “Contact” page or give us a call at 704-370-2828. We handle land use, zoning, and condemnation legal matters in federal court, in Mecklenburg County and elsewhere in North Carolina. We have offices in Charlotte, Lake Norman, and Union County.