Taxability of Loss of Remainder in Partial Easement of Primary Residence

[judgedave]

My question concerns the future taxability of a payment the State of Illinois will be paying to a client for covering a Loss of Remainder caused by a partial easement of his property to enable widening of a road. The appraiser has lowered FMV from 181,000 to 138,000 (43k Loss of Remainder). My specific question is: Is the payment of 43,000 taxable, or is it non-taxable with cost basis simply dropping from 181k to 138k. My interpretation of pub544 is that it would only be taxable in excess of 43,000 (say they print him a check for 48,000=5,000 taxable). Another site I looked at leads me to believe it would be a taxable capital gain, in excess of what he spends to raise the FMV (ie 43,000 check - 20,000 spent on improvements= 23k taxable). Thank you for your insights!

[Burke]

Easements are considered a sale of the portion affected. It is applied to reduce the owner's basis in the property. If he receives an excess over the basis allocated to that portion, then his basis is reduced to zero for that portion, and there is a taxable gain to report for the excess amount. FMV has nothing to do with it, except perhaps to calculate how much the buyer is going to pay the owner. Basis is the owner's original cost and improvements, if any.

[Roland Slugg]

Where in Pub 544 did you read that? How easements are treated is covered in the LLH corner on page 3. The amount received is like a return of capital ... non-taxable unless it exceeds the basis of the property.

I respectfully disagree with Burke's reply above. Easements are NOT treated like a sale, and no allocation of the property's basis to the "affected portion" is required in most cases. An allocation is only necessary when an easement affects one portion of a parcel but not other portions. Based on the facts presented, the situation in the OP appears to be a straightforward situation of a single lot or parcel beside which the road and/or sidewalk was widened. Simple basis reduction ... no taxable gain unless the $43k received exceeds the basis of the entire parcel.

[judgedave]

Where in Pub 544 did you read that? How easements are treated is covered in the LLH corner on page 3. The amount received is like a return of capital ... non-taxable unless it exceeds the basis of the property.

I respectfully disagree with Burke's reply above. Easements are NOT treated like a sale, and no allocation of the property's basis to the "affected portion" is required in most cases. An allocation is only necessary when an easement affects one portion of a parcel but not other portions. Based on the facts presented, the situation in the OP appears to be a straightforward situation of a single lot or parcel beside which the road and/or sidewalk was widened. Simple basis reduction ... no taxable gain unless the $43k received exceeds the basis of the entire parcel.

As I have re-read Pub 544, I would categorize what the State of Illinois is calling Loss of Remainder as Pub544-defined Treatment of Severance Damages.

From Pub544...
"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 severance damages.
If your net severance damages are more than the basis of your retained property, you have a gain."

As the $43k would be far less than the cost basis of the retained property, then I agree that the payment would not cause a taxable gain, but it would lower the cost basis by that $43k for future disposition considerations of his primary residence.