High Speed Rail: Tax Aspects of Condemnation

High Speed Rail: Tax Aspects of Condemnation By Robert G. Fishman 1 I. INTRODUCTION. This article 2 addresses the income tax consequences under section 1033 of the Internal Revenue Code of 1986, as amended (the Code ) of the taking of property by the California High-Speed Rail Authority ( Rail Authority ) by condemnation or sale under threat of condemnation. 3 It also discusses briefly how replacement property may be assessed at a carryover value for property tax purposes. II. CONDEMNATIONS WITHOUT UTILIZING CODE SECTION 1033; GAIN REALIZED & RECOGNIZED; CAPITAL GAIN TREATMENT Not all persons from whom property is taken by condemnation or threat thereof desire or are able to take advantage of deferral under Code section 1033; this section deals with the taxation of such non-qualifying takings. Code section 1001 provides that if property is sold or otherwise disposed of, gain shall be the excess of the amount realized therefrom over adjusted basis of the property. The amount realized is the sum of money plus the fair market value of property received. It goes on to provide that [e]xcept as otherwise provided in this subtitle, the entire amount of gain or loss... on the sale or exchange of property shall be recognized. 4 Losses are recognized, unless otherwise provided in Subtitle A of the Code. 5 Net long term capital gains are taxed to individuals at a lesser rate than ordinary income. Therefore, if property is condemned or sold under threat or imminence of condemnation, and the deferral of gain under Code section 1033 is not desired or anticipated, obtaining long term capital gain treatment is essential. 6 If condemned real property is held for sale to customers or constitutes harvested crops, gain from the condemnation proceeds is ordinary income. 7 If the condemned property is held for more than one year and is property is used in the trade or business, then it is afforded special capital gain tax treatment. Property used in the trade or business is basically of two types: 8 (i) depreciable property if used in the trade or business (e.g., buildings, equipment, and in the case of farming, vines, fruit trees, irrigation equipment and the like); and (ii) non-depreciable real estate not held for sale to customers. In the case of unharvested crops on land used in the trade or business and held for more than one year, if the crop and land are sold at the same time to the same person, the crop qualifies for capital gain treatment. 9 III. CODE SECTION 1033, THE BASICS This article deals with involuntary conversions by condemnation or threat or imminence thereof. Code section 1033 is labeled Involuntary Conversions. Condemnation or threat of condemnation is a type of involuntary conversion; 10 the two terms, involuntary conversion and condemnation are often used interchangeably. Code section 1033 is an exception to the gain recognition rule of Code section 1001(c) and provides generally that no gain is recognized if property is condemned or sold as a result of threat or imminence of condemnation, the taxpayer elects Code section 1033 treatment and within a certain period the seller purchases qualifying replacement property, the cost of which equals or exceeds the condemnation award or sales price of the condemned property. Code section 1033 is a relief provision enacted to allow taxpayers to replace property involuntarily converted without recognizing gain. 11 As such, Code section 1033 is construed liberally to achieve its intended purpose. 12 Code section 1033 applies only to gains; losses from involuntary conversions are recognized or not recognized without regard to Code section 1033. 13 IV. GOVERNMENT TAKING OR VOLUNTARY SALE UNDER THREAT OR IMMINENCE OF CONDEMNATION; KNOWLEDGE OF SELLER; SALE TO THIRD PARTY; LEASEBACKS AND OPTIONS The favorable tax treatment afforded by Code section 1033 applies in two general circumstances: (i) an actual taking by governmental authority through seizure, requisition or condemnation; or (ii) the voluntary sale of the converted property under a threat or imminence of condemnation. The Internal Revenue Service ( IRS ) has defined condemnation as the process by which private property is legally taken for public use without the owner s consent. 14 An involuntary taking or seizure by government Summer 2013 19

or a governmentally authorized entity is uncontroversial and qualifies is a condemnation within the meaning of Code section 1033. However, for voluntary sales to qualify under Code section 1033: (i) a threat or imminence condemnation must first occur; (ii) the entity threatening to condemn must have the legal power to do so; 15 (iii) the entity seeking the property must itself have made a threat of condemnation, or there must be a known imminence of condemnation; 16 (iv) the threat can be either oral or in writing; 17 (v) the property owner must be informed about the threat; 18 (vi) the property owner has reasonable grounds to believe that condemnation will in fact occur if he does not voluntarily sell; 19 and (vii) the condemnation must not be remote. 20 There is no threat or imminence of condemnation where the public body having authority to condemn only considered the taxpayer s property and did not, by public resolution or public act, specifically designate the geographical area that will be condemned. 21 Confirmation of intent to condemn from a representative of the governmental body is normally sufficient to prove threat or imminence of condemnation. 22 But, it must be reasonable for a taxpayer to infer that the representative of the public body spoke with sufficient authority to make it likely that his threats would and could be carried out. 23 A court filing of notice of condemnation is not required for there to be threat or imminence. 24 The IRS has ruled that the taxpayer had reasonable grounds to believe that condemnation was threatened or imminent if a quasi-governmental agency does not have to have current authority to condemn, but can reasonably obtain it. 25 The taxpayer has the burden of proof that threat or imminence of condemnation exists. 26 The sale of property to a third party and not the condemning authority qualifies under Code section 1033 if the threat or imminence of condemnation is present. 27 The IRS has ruled that Code section 1033 qualification is not jeopardized if the government acquires property under threat of condemnation before it is needed, and leases it back to the seller. 28 An option to purchase property by the condemning authority along with a rental arrangement prior to sale (exercise of the option) qualifies under Code section 1033 if made under threat or imminence of condemnation, but rent paid under the lease is not part of the condemnation proceeds and therefore not deferrable under Code section 1033. 29 V. ECONOMIC UNIT THEORY If only a portion of the taxpayer s property is taken by the condemning authority and the remaining portion is rendered no longer economically viable, the taxpayer may qualify a sale of non-taken property to a third party as an involuntary conversion qualifying for Code section 1033 treatment. 30 Under this economic unit theory, a taxpayer must show that his property that was not taken by the condemning authority could no longer practically be used in his business. 31 The Tax Court in Forest City Chevrolet 32 denied Code section 1033 treatment where the noncondemned parcel was sold because of encroachment by the university, and not because the condemnation seriously jeopardized the taxpayer s business. Compare Masser, 33 in which the Tax Court treated the sale of the non-condemned parcel as an involuntary conversion under the economic unit theory. 34 VI. ELECTING CONDEMNATION TREATMENT; REPORTING REQUIREMENTS Code section 1033(a)(2)(A) requires that the taxpayer make an election under Code section 1033, and that, the election shall be made at such time and in such manner as the Secretary may by regulations prescribe. The Treasury Regulations state that the details in connection with the involuntary conversion shall be reported in the return for the taxable year in which any part of the gain is realized. 35 Unfortunately, the Treasury Regulations do not elaborate on what those details might be. The Treasury Regulations also state: A failure to so include such gain in gross income in the regular manner shall be deemed to be an election by the taxpayer to [claim Code section 1033 treatment] even though the details in connection with the conversion are not reported in such return. 36 Thus, under the Treasury Regulations, the taxpayer can elect Code section 1033 treatment merely by not reporting the condemnation on his return; not providing additional details with the return does not negate the effectiveness of the election. The Treasury Regulations also state that the details in connection with the acquisition of replacement property must also be reported on the return for such year. 37 What those details might be are not spelled out in the Treasury Regulations. 38 VII. QUALIFYING REPLACEMENT PROPERTY UNDER CODE SECTION 1033(A)(2)(A) SIMILAR OR RELATED IN SERVICE OR USE Code section 1033(a)(2)(A) states that for nonrecognition to apply the replacement property must be similar or related in service or use to the property so converted. The similar use rule requires that the end use of the replacement property must be substantially similar to the use of the property taken. However, similar use does not mean the replacement property must be identical with the property taken; substantially similar is sufficient. In applying the similar or related in service or use test, the 20 Summer 2013

IRS has ruled that the factors it will consider in making a favorable determination are: (i) whether the properties are of a similar service to the taxpayer; (ii) whether the nature of the business risks connected with the properties are similar; and (iii) what such properties demand of the taxpayer in the way of management, services and relations with tenants. 39 Proceeds from the condemnation of unimproved real estate that are invested in improved real estate do not qualify for the similar or related service or use test. 40 Improvements to the taxpayer s retained property can qualify under Code section 1033 if similar or related in service or use. 41 Replacing rental property with a business that the taxpayer operated (i.e., did not rent) was not similar or related in service or use. 42 If a business is condemned (e.g., a carwash) and the taxpayer improves his remaining property with a different type business (e.g., a farm), the two are not related in service or use. 43 VIII. CODE SECTION 1033(G) BUSINESS AND INVESTMENT REAL ESTATE: LIKE- KIND TEST Code section 1033(g) treats certain real property as meeting the related in service or use test of Code section 1033(a)(2)(A) if it meets all of the following: (i) the involuntarily converted and replacement property must both be real estate; (ii) the involuntarily converted and replacement property must be held either for the productive use in a trade or business or for investment; (iii) the replacement property must be of a like-kind to the taken property; (iv) the property cannot be stock in trade or held for sale to customers; (v) the taken property must have been condemned, or sold as a result of actual or threatened seizure, requisition or condemnation; and (vi) neither the taken nor replacement property may be personal use property. As discussed in greater detail below, qualifying under Code section 1033(g) gives the taxpayer an additional year to acquire replacement property than is available under Code section 1033(a)(2)(A). 44 The benefit of Code section 1033(g) cannot be understated; it extends nonrecognition of gain treatment under Code section 1033 to taxpayers whose business or investment real property is involuntarily converted and who acquire replacement real property of a like-kind even though that replacement property is not similar or related in service or use to the converted property. Further, it extends the period to replace the converted property from two years to three years after the recognition year. 45 Code section 1033(g)(1) has been interpreted by the IRS to have the same meaning as the like-kind Treasury Regulations under Code section 1031. 46 According to the Treasury Regulations under Code section 1031, like-kind refers to the nature or character of real property, and not to its grade or quality. 47 The fact that the taken or replacement real estate is improved or unimproved is not material, for that relates only to the grade or quality of the property and not to its kind or class. 48 The like-kind rule of Code section 1033(g) does not apply to land improvements constructed by the taxpayer on his own land. The IRS takes the position that improvements to land are not of a like-kind to land for purposes of Code section 1033(g) because land is not of the same nature or character as a building...or road. 49 However, improvements made to land owned by the taxpayer may qualify under the more stringent similar or related in service or use test of Code section 1033(a)(2) (A); 50 but the physical characteristics and end uses of the converted and replacement property (improvements) must be closely similar. 51 IX. REPLACEMENT PROPERTY ACQUIRED FROM RELATED PERSON The deferral of gain under Code section 1033 does not apply if the replacement property is acquired from a related person, 52 such as a sibling, spouse, parent or child. The related person limitation applies to C corporations, and to individual taxpayers to the extent gain realized in an involuntary conversion exceeds $100,000 for the taxable year. 53 If the related party acquired the replacement from an unrelated person within the replacement period of Code section 1033(a)(2)(B), then the related person limitation does not apply. 54 X. CODE SECTION 1033 AMOUNT OF GAIN RECOGNIZED; WHEN GAIN IS RECOGNIZED In the case of an involuntary conversion, gain (if any) shall be recognized, at the election of the taxpayer, to the extent the amount realized upon the conversion exceeds the cost of qualified replacement property. 55 That is, the amount recognized is the lesser of: (i) the gain realized on the condemnation; or (ii) the amount by which the condemnation proceeds exceed the cost of the replacement property. 56 The gain is realized in the taxable year in which the taxpayer first receives payments that exceed his basis in the condemned property, even though that may represent only a partial or advance payment of the condemnation award. Waiting until the final condemnation award is determined will not delay the term of the replacement period under Code section 1033(a)(2)(B). 57 If a partial condemnation award is received in one year, but the final award is delayed to a later year, requesting an IRS extension of the replacement period may be advisable. Summer 2013 21

XI. TAX BASIS OF REPLACEMENT PROPERTY Where qualified replacement property is acquired within the replacement period, then the basis of the replacement property is its cost reduced by the amount of gain that is not recognized. 58 If the cost of the replacement property exceeds that received for the property taken, the excess is a capital expenditure that is added to the basis of the replacement property. 59 If a taxpayer either desires to pay the tax on the condemnation and not elect Code section 1033 treatment, or is unable to purchase replacement property, then the entire gain (if any) on the condemnation is recognized. If the taxpayer purchases replacement property after the statutory replacement period, the taxpayer s basis is its cost. 60 The basis of qualified replacement property in a Code section 1033 transaction must be allocated based on the relative cost of land and improvements of the replacement property. 61 Treasury Regulation section 1.167(a)-5 has been cited as authority for allocation of basis to replacement property consisting of both depreciable and non-depreciable property. 62 If the replacement property contains both depreciable and non-depreciable property (e.g., trees and land), then the basis must be allocated to the depreciable property portion and non-depreciable property portion as the value of each bears to the total purchase price of the replacement property. 63 XII. CONDEMNATION OF MULTIPLE PROPERTIES OR A GOING BUSINESS; ALLOCATION OF GAIN OR LOSS In the case of an involuntary conversion of a going business consisting of several types of assets (e.g., building and equipment) or of separate parcels, the condemnation proceeds and therefore gain or loss can be allocated separately to the properties sold or converted. Therefore, the taxpayer can defer gain by treating some assets as qualifying under Code section 1033, and recognize gain (or loss) on other assets not replaced, 64 even though part of the same sale transaction. The IRS has ruled that [t] he selling price must be allocated among all the assets sold according to their respective fair market values, and separate computations must be made of the gain or loss with respect to each asset sold for which there is a separately identifiable basis for making this computation possible. 65 The IRS permits allocation of value to separate assets of a going business even if the condemnation award does not separately state values. Nonetheless, if separate tax treatment for each asset is wanted, it may be desirable to have the condemning authority allocate values separately in its award to avoid later problems of proof. 66 XIII. REPLACEMENT PERIODS; IMPROVEMENTS ON RETAINED LAND In order to qualify for deferral of gain in the case of an involuntary conversion, the taxpayer must replace the converted property with eligible replacement property within a specified period. The replacement period begins on the earlier of: (i) the date of disposition of the converted property; or (ii) the date in which the condemnation or requisition was first threatened or imminent. 67 The replacement period ends either two years after the close of the first taxable year in which any part of the condemnation gain is realized 68 or, in the case of like-kind property under Code section 1033(g), three years from the close of the first taxable year in which any part of the condemnation gain is recognized. 69 As cited above, placing improvements on land already owed by the taxpayer does not qualify as like-kind property under Code section 1033(g). It follows then that the threeyear replacement period Code section 1033(g)(4) is also not available. If improvements are made to the taxpayer s property, to qualify under Code section 1033 only the two year period of Code section 1033(a)(2)(B) applies and then only to the extent the improvements are similar or related in service or use to the property converted. 70 In a 1994 letter ruling, the IRS held however that improvements made to replacement property purchased by the taxpayer (not already owed) are of a like-kind qualifying under Code section 1033(g) and therefore the taxpayer has three years under Code section 1033(g)(4) to complete those improvements. 71 Although letter rulings cannot be used or cited as precedent, it sets forth the IRS s more liberal likekind replacement property provisions, and consequently three-year replacement period. 72 XIV. REQUESTS FOR EXTENSION OF THE REPLACEMENT PERIOD If a taxpayer is unable to find replacement property within the two or three-year replacement periods of Code section 1033(a)(2)(B) or Code section 1033(g)(4), the Code specifically provides that the IRS may authorize a later date in which to purchase replacement property and still qualify under Code section 1033. 73 The Treasury Regulations state generally that the application for extension must be made prior to the last day of the close of the statutory period, and must state reasonable cause. 74 Requests for extension based on high market value or scarcity of replacement property are generally not sufficient grounds for granting an extension, but each case is evaluated on its facts and circumstances. 75 Normally, extensions are limited to a period not to exceed one year. 76 If the application is late, the taxpayer can still apply for an extension upon a showing of reasonable cause 22 Summer 2013

and application within a reasonable time after the expiration of the replacement period. 77 There is a malpractice risk if counsel does not have tax expertise and did not advise the taxpayer to request an extension within the time permitted by the regulations. The Tax Court has denied the taxpayer s tardy request for extension as not due to reasonable cause where the accountant upon whom the taxpayer relied lacked tax expertise sufficient to justify such reliance. 78 XV. DEPRECIATION RECAPTURE Depreciation is generally recaptured as ordinary income on the sale (including involuntary conversions) of depreciable property. Depreciation recapture is of two varieties: (i) Code section 1245 recapture; and (ii) Code section 1250 recapture. Code section 1245 recapture generally applies with respect to tangible personal property ( Section 1245 Property ) and the amount recaptured can apply to all depreciation taken. 79 Generally, Code section 1250 applies to depreciable real property (e.g., buildings), and Code section 1250 recapture is limited to depreciation deductions taken in excess of the straight line. 80 Recapture under Code sections 1245 and 1250 is treated as ordinary income. In the case of Code section 1245 recapture, depreciation recapture on the sale or exchange of Section 1245 Property (including involuntary conversions) is the lower of: (i) the recomputed basis of the taken property; or (ii) the amount realized in excess of the adjusted basis of the property. 81 Recomputed basis is generally the taken property s basis adding back depreciation taken. 82 If the taken property is sold at a loss (tax basis exceeds the amount realized) there is no depreciation recapture. Code section 1245(a)(1) states that depreciation recapture applies to any disposition of Section 1245 Property notwithstanding any other provision of Subtitle A of the Code. This means that if there is a disposition of Section 1245 Property as part of an involuntary conversion, the rules of both Code sections 1033 and 1245 must be applied, and the later supersedes the former. However, Code section 1245(b) (4) limits the amount of Code section 1245 depreciation recapture in the case of an involuntary conversions if the replacement property also consists of Section 1245 Property. 83 Where property sold consists of both Section 1245 Property and non-section 1245 Property, the Treasury Regulations require that the gain recognized must be allocated between the two in proportion to their relative fair market values. 84 If the condemned and replacement property both consist of Section 1245 Property and non- Section 1245 Property, the Treasury Regulations provide rules for determining how gain is calculated. 85 The IRS has ruled that a vineyard is Section 1245 Property. 86 Orchards are also considered to Section 1245 Property under the same analysis. Therefore, when a vineyard or orchard is sold (including involuntary conversions), the calculation of ordinary income and capital gain are determined pursuant to the Treasury Regulations under Code section 1245. 87 Under the Treasury Regulations, any reasonable method of allocation, either in the condemnation award or by appraisal, may be permitted to allocate the purchase price between vineyard or orchard, and land. 88 XVI. SEVERANCE DAMAGES; PLANNING FOR SEVERANCE DAMAGES Severance damages are amounts paid by the condemning authority for damages to the retained property of the taxpayer. Severance damages are analogous to property insurance; they represent compensation for damage to property. 89 The IRS has stated, [d]amages in addition to an award paid for the property actually condemned, when the value of the retained property has decreased as a result of the condemnation, are called severance damages. 90 Severance damages reduce the basis of the remaining property, and to the extent they exceed that basis, taxable gain results. 91 If severance damages are awarded only with respect to a specific portion of the taxpayer s retained property, then only the basis of that portion of the property is reduced by the severance damages received, and any excess over that basis is taxable gain. 92 Severance damages are treated the same for tax purposes as non-severance condemnation proceeds in that they can be reinvested in qualified replacement property to prevent gain from being recognized, 93 and can be reinvested in like-kind property under Code section 1033(g)(1). 94 If severance damages used to build improvements on the retained property must be similar or related in service or use to the damaged property under the more restrictive test of Code section 1033(a)(2)(A), and cannot qualify as like- kind under Code section 1033(g) or qualify for the three-year replacement period of Code section 1033(g)(4). 95 But if the taxpayer purchases new replacement property, improvements thereto may qualify under the like-kind rule and under the extended replacement period of Code section 1033(g)(4). 96 The basis of retained property is first reduced by the amount of severance damages; gain is recognized only to the extent the severance payment exceeds its basis. If only a portion of the taxpayer s property is taken, it may be advantageous to allocate some of the condemnation award to severance damages, especially if the retained property has a high basis or the taxpayer does not want to purchase replacement property. Severance damages attributable to the taxpayer s loss of business may result in ordinary income, and severance damages should be allocated to a diminution in value of the retained property. If severance damages are Summer 2013 23

not stated in the condemnation award or agreement of sale of the taken property, the taxpayer may have difficulty in establishing after-the-fact that part of his award or payment is severance. This is the case even though damages to retained property were considered in determining the amount of the condemnation award or purchase price. The IRS has ruled: When it is not clearly shown that the award includes a specific amount as severance damages it will be presumed that the proceeds were given in consideration of the property taken by the condemning authority. 97 Courts are reluctant to rewrite the plain and literal meaning of a contract. 98 The taxpayer has the burden of proof as to the amount to be allocated to severance damages. 99 To prevail, the taxpayer must provide strong evidence of severance damages in calculating the award, such as, an itemized statement or closing sheet at the time of settlement and payment by the condemning authority which indicates the specific amount of the total contract purchase price which is for severance damages. 100 XVII. AFTER AN INVOLUNTARY CONVERSION, PROPERTY TAXES OF THE REPLACEMENT PROPERTY MAY BE REDUCED In 1982, the voters approved Proposition 3 which amended Article XIIIA of the California Constitution ( Proposition 13 ) by adding a new section 2(d) ( Section 2(d) ). Section 2(d) provides that a change in ownership does not include the acquisition of real property as a replacement for comparable property if the person acquiring the real property was displaced from by acquisition by a public entity. Under this provision, replacement property acquired in a qualifying Code section 1033 transaction may also qualify for a type of carryover assessed value for property tax purpose. But the test for qualifying the replacement property under Section 2(d) differs and is more restrictive than the similar or related in service or use, or likekind, tests of Code section 1033. Under Section 2(d), the replacement property must be similar in size, utility and function to the property replaced. The California Code of Regulations goes into greater detail as to comparability of replacement property. 101 There are California Revenue and Taxation Code ( R&T Code ) sections and tax regulations implementing and interpreting Proposition 13. In particular, R&T Code section 68 provides for a type carryover adjusted base year value of replacement property. R&T Code section 68 also contains a requirement that persons claiming this special assessment shall do so within four years of the date the condemned property was taken, 102 even though the California Constitution does not state any application of such a time limit. XVIII. FAILURE TO MEET CODE SECTION 1033 REQUIREMENTS: REPORTING, INTEREST, PENALTIES A taxpayer may fail to meet the requirements of Code section 1033 necessary to defer all gain realized where, for example: (i) the taxpayer failed to purchase replacement property within the statutory period; (ii) the replacement property was not within the statutory definition of similar or related in service or use under Code section 1033(a) (2)(A), or of a like-kind under Code section 1033(g); (iii) the property was replaced but at a lower cost than was anticipated; or (iv) the taken property was subject to Code section 1245 recapture without reinvestment in Section 1245 Property as replacement property. Treasury Regulation section 1.1033(a)-2(c)(2) states that if an election was made (in the year gain was first realized), but ultimately the taking did not qualify under Code section 1033, the tax liability for the election year must be recomputed and an amended return filed with the additional income tax, if any, owed for that year. Interest on any underpayment of taxes for the election year is automatically assessed under Code section 6601(e)(1). Accuracy related penalties are assessed under Code section 6662, on substantial understatements of income tax at a rate of 20 percent of the underpayment. However, Code section 6662(d)(2) (B) provides that if relevant facts affecting the item s tax treatment are adequately disclosed in the return or statement attached, then the amount of the underpayment (upon which the penalty is calculated) is reduced. The Treasury Regulations cover the circumstances and method of making adequate disclosure to avoid or reduce the penalty. 103 To avoid the possibility of a Code section 6662 underpayment penalty for a failed Code section 1033 transaction, it might be prudent on the original election year return to disclose all the details relating to the condemnation. XIX. CONCLUSION Clearly, if the Rail Authority condemns or purchases a taxpayer s property under threat or imminence of condemnation, the taxpayer will qualify under Code section 1033 to defer recognition of gain, provided qualified replacement property is purchased within the statutory period. However, by applying the pre- and post-condemnation planning discussed in this article, the taxpayer may reduce or eliminate the tax cost of nonqualified or failed involuntary conversions. ENDNOTES 1. Robert G. Fishman is a shareholder in the law firm of Fishman, Larsen Goldring & Zeitler in Fresno, California. Mr. Fishman is a member of the State Bar of California Tax Section 24 Summer 2013

and also admitted to the United States Tax Court. Mr. Fishman has an LL.M. (Taxation) from New York University and is a Certified Specialist in Taxation as certified by the State Bar of California. He may be reached at (559) 256-5000 or by email at fishman@flgz.net. 2. Examples cited in the endnotes to this article illustrate the concepts discussed. Each such example ( Example ) may be found at: http://flgz.net/1033.pdf. 3. The Rail Authority prepared an informational pamphlet entitled Your Property, Your High-Speed Rail Project, first published in November 2009, and recently updated in December 2012. This pamphlet is available online via the Rail Authority s web site at http://www.cahighspeedrail.ca.gov. It states that the Rail Authority is a public agency that has the statutory authority to purchase private property for public use under the California Eminent Domain Law and the state and federal Uniform Relocation Assistance and Real Property Acquisition Policies Act. In this article, the author has assumed that the Rail Authority has or can obtain the necessary legal authority to acquire private property through eminent domain. 4. IRC 1001(a), (b) and (c). 5. IRC 1001(a) and (c). See Examples 1 and 2. 6. Capital gain rates increased for high income taxpayers under American Taxpayer Relief Act of 2012. 7. IRC 1221(a)(1) and 1231(b)(1)(A) and (B). 8. IRC 1231(b)(1). 9. IRC 1231(b)(4). See Examples 3, 4 and 5. 10. Another type of involuntary conversion is destruction such as by fire, flood or hurricane. 11. John Richard Corp. v. Comm r, 46 T.C. 41, 44 (1966). 12. Filippini v. United States, 318 F.2d 841, 844 (9th Cir. 1963); Orders v. U.S., 14 AFTR 2d 5092 (1964); John Richard Corp. v. Comm r, supra; Davis Regulator Co., 36 B.T.A. 437, 443 (1937); Massillon-Cleveland-Akron Sign Co. v. Comm r, 15 T.C. 79, 83 (1950). 13. Treas. Reg. 1.1033(a)-1(a). 14. For a more lengthy definition of condemnation, see Publication 544 (2011), Sales and Other Dispositions of Assets, found at http://www.irs.gov/publications/p544. 15. The Davis Company, (1927) 6 BTA 281, acq. 16. Forest City Chevrolet, TC Memo 1977-187. 17. Michael H. Johnson, et. ux. v. Comm r, TC Memo 1998-448. 18. Rev. Rul. 63-221, 1964-2 CB 319. 19. Frank O. Maixner, et. al. v. Comm r, 33 T.C. 191 (1959), acq.; Carson Estate Co, (1963) TC Memo 1963-90; Dominguez Estate Co, (1963) TC Memo 1963-112. 20. Michael H. Johnson, supra. 21. Rev. Rul. 58-557, 1958-2 CB 402. 22. Rev. Rul. 63-221, 1963-2 CB 332. 23. Maixner, supra, acq. 24. Carson, supra; Dominguez, supra. 25. Rev. Rul. 74-8, 1974-1 CB 200. 26. Carson Estate, supra. 27. Creative Solutions, Inc. v US, 320 F 2d 809 (5 th Cir. 1963); Rev. Rul. 81-180, 1981-2 CB 161. The Tax Court in Joseph P Balistrieri, TC Memo 1979-115, considers the issue settled. 28. Rev. Rul. 57-70, 1957-1 CB 260. 29. Rev. Rul. 57-261, 1957-1 CB 262. See Examples 6, 7, 8, 9, 10 and 11. 30. Rev. Rul. 59-361, 1959-2 CB 183. 31. Id. 32. Forest City Chevrolet, supra. 33. In Masser, 30 TC 741 (1958), the taxpayer, an interstate trucker, owned two adjacent parcels across the street from one another, one being a terminal building and the other vacant lots he used for parking his trucks. Faced with imminent condemnation of the vacant lots by the Housing Authority, the taxpayer sold the lots to the Housing Authority and the terminal to a third party. The taxpayer alleged that it was economically impractical without adjacent parking space to operate the non-condemned terminal, and the Tax Court agreed and granted Code section 1033 treatment for the terminal parcel. The Court held that the two parcels constituted one economic unit and therefore treated the sale of both parcels as an involuntary conversion even though there was no threat of condemnation of the terminal parcel. In the trucking business, it is acceptable practice to have adequate parking space adjacent to the terminal building. The lots were used for the parking of trucks and equipment operating in and out of the terminal building. Another parking lot was available a mile away from the terminal, but it would have been economically impractical because of the expense, delays in delivery, adverse customer relations and increased hazards of traffic accidents and cargo thefts to park there. In holding that the sale of the terminal parcel also qualified as an involuntary conversion under Code section 1033 under the theory of one economic unit, the Court cited two basic principles that taxation is eminently practical and that Code section 1033 is a relief provision which should be liberally construed. Summer 2013 25

34. See Example 12. 35. Treas. Reg. 1.1033(a)-2(c)(2). 36. Id. 37. Treas. Reg. 1.1033(a)-2(c)(2). 38. IRS Publication 544 dealing with Involuntary Conversions mirrors the Treasury Regulations but does not state what should actually be reported on the return. See Example 13. 39. Rev. Rul. 80-184, 1980-2 CB 232; Rev. Rul. 64-237, 1964-2 C.B. 319; PLR 9603012. 40. Treas. Reg. 1.1033(a)-2(c)(9)(i). 41. Rev. Rul. 60-69, 1960-1 CB 294. 42. Lynchburg National Bank & Trust Co. v. Comm r, 20 TC 670 (1953). 43. Arnold L. Santucci, TC Memo 1973-178. See Examples 14, 15 and 16. 44. IRC 1033(g)(4). 45. Id. 46. Treas. Reg. 1.1033(g)-1(a) [last sentence]; PLR 200219006. 47. Treas. Reg. 1.1031(a)-1(b). 48. See Examples 17 and 18. 49. Rev. Rul. 67-255, 67-2 CB 270; Rev. Rul. 76-390, 1976-2 CB 243; Rev. Rul. 76-391, 1976-2 CB 243; Rev. Rul. 71-41, 1971-1 C.B. 223; PLR 9619028. 50. Rev. Rul. 71-41, supra; Rev. Rul. 67-254, 1967-2 C.B. 269. 51. Rev. Rul. 64-237, 1964-2 C.B. 319; Rev. Rul. 76-390, supra; Rev. Rul. 76-391, supra. See Examples 19, 20 and 21. 52. IRC 1033(i)(1). 53. IRC 1033(i)(2)(A)-(C). 54. IRC 1033(i)(1). See Example 22. 55. IRC 1033(a)(2)(A); Treas. Reg. 1.1033(a)-2(c)(1). 56. See Examples 23 and 24. 57. See William T. Shipes Jr. v. Comm r, TC Memo 1997-304, in which the taxpayer received a supplemental condemnation payment in a later year. The court held that the replacement period began when gain was first realized upon receipt of the initial payment; nothing in the Internal Revenue Code or Treasury Regulations provides for multiple replacement periods. See also, Robert J. Wilson v. Comm r, TC Memo 1996-418. 58. IRC 1033(b)(2). 59. Treas. Reg. 1.1033(b)-1(a) Example, last sentence. See Examples 25 and 26. 60. See Example 27. 61. IRC 1033(b)(2); Rev. Rul. 73-18, 1973-1 CB 368. 62. Rev. Rul. 79-402, 1979-2 C.B. 297 63. Id. See Example 28. 64. Rev. Rul. 70-501, 1970-2 CB 163; Orders v. US, supra. 65. Rev. Rul. 70-465, 1970-2 C.B. 162. 66. See Example 29. 67. IRC 1033(a)(2)(B). 68. IRC 1033(a)(2)(B)(i). 69. IRC 1033(g)(4). See Examples 30, 31 and 32. 70. Rev. Rul. 67-254, 1967-2 C.B. 269. 71. PLR 9421002. 72. See Examples 33 and 34. 73. IRC 1033(a)(2)(B)(ii). 74. Treas. Reg. 1.1033(a)-2(c)(3). 75. Rev. Rul. 60-69, 1960-1 CB 294. 76. Id. 77. Treas. Reg. 1.1033(a)-2(c)(3)(i) and (ii). 78. Marco S. Marinello Associates, Inc., TC Memo 1975-78, aff d on other issues (1976, CA1) 535 F2d 147. See Example 35. 79. IRC 1245(a)(1). 80. IRC 1250(a)(1). 81. IRC 1245(a)(1). 82. IRC 1245(a)(2). 83. Treas. Reg. 1.1245-4(d)(2), Example (2). 84. Treas. Reg. 1.1245-1(a)(5). 85. Treas. Reg. 1.1245-4(d)(4); Treas. Reg. 1.1245-4(d)(5) Example (i). See Examples 36 and 37. 86. Chief Counsel Advice 201234024. 87. Treas. Reg. 1.1245-1(b). 88. Treas. Reg. 1.1245-1(a)(5). 26 Summer 2013

89. Rev. Rul. 68-37, 1968-1 C.B. 359. 90. Rev. Rul. 83-49, 1983-1 C.B. 191. 91. G.C.M. 23698, C.B. 1943; Rev. Rul. 68-37, supra; Rev. Rul. 83-49, supra. 92. Rev. Rul. 68-37, supra. See Example 38. 93. Rev. Rul. 83-49, supra; Rev. Rul. 60-240, 1969-1 CB 199. 94. Id. See Example 39. 95. See Section VII, above, dealing with qualifying replacement property, and Rev. Rul. 67-254, supra. Note that in Rev. Rul. 67-254, the taxpayer used condemnation proceeds to improve his retained property that met the similar or related in service or use test of Code section 1033(a)(2)(A), and not Code section 1033(g). Rev. Rul. 71-41, supra. 97. Rev. Rul. 59-173, 1959-1 CB 201; Marshall C. Allaben, 35 BTA 327 (1937); Lapham v. U.S., 178 F. 2d 944 (1950). But see Marco S. Marinello Associates, Inc., supra, where the Tax Court reallocated some of the payment made for the direct taking as attributable to severance damages based on the written appraiser s report. 98. William Greene v. U.S., (1959, DC IL) 3 AFTR 2d. 1461. 99. Marco S. Marinello Associates, Inc., supra. 100. Rev. Rul. 64-183, 1964-1 CB 297. 101. 18 CCR 462.500(c). 102. 18 CCR 462.500(g) expands upon this time limit requirement. 103. Treas. Reg. 1.6662-4(e) and (f). 96. See Section XIII, above, dealing with replacement period. See Example 40. Summer 2013 27