Severance damages are where I see the most left on the table in a partial taking. I spent years on the legal side of condemnation cases, and the moment the ink dries on the settlement is not the end of the client’s story; it is the start of a different one. The authority moves on. The client is holding a check and a set of tax consequences that sat outside everyone’s engagement. Allocated before closing, severance damages absorb a large share of the award against basis. Ignored, they are taxed as sale proceeds. This issue is the severance damages field guide, with a first look at recapture to close.
Negotiate the allocation before closing, not after
In a partial taking the authority pays for two things: the property taken and the damage to what remains. The second payment is where the tax planning lives, and it is controlled almost entirely by what the closing documents say before they are signed. The settlement should state the allocation in dollar amounts, not percentages or ratios; a letter or memorandum after execution will not substitute. If the client is still at the table, this is the conversation to have today. The full sequence: severance damages, negotiate the allocation before closing.
What appraisal evidence the IRS requires
An allocation in the agreement is necessary but not sufficient. The IRS expects credible appraisal evidence that the retained parcel actually lost the value attributed to it, and without that support it can recharacterize the whole award as payment for the property taken. Our position on the settlement language is that less is best: a single global number in the formal document, with the before-and-after appraisal and the analysis in the client’s close-out file, so the tax team keeps room for the most favorable supportable position. The method and the three approaches that fail: what the IRS wants to see for severance.
Rev. Rul. 83-49: the client is not limited to restoring the remainder
When severance damages exceed the basis of the retained parcel, Rev. Rul. 80-184 treats the excess as gain in the year of receipt. Rev. Rul. 83-49 then holds that the gain can be deferred under Section 1033 into any qualifying replacement property, not only repairs to the land kept. The two rulings work together: one says when gain is triggered, the other how to defer it, and few files use the second. The article: replacement property after a partial taking.
Section 1245 and Section 1250 are not the same number
Most clients, and many advisors, treat depreciation recapture as one line. In a condemnation of commercial or income-producing property it is two calculations under two Code sections, at two rates, triggered at two points. Section 1245 on equipment is ordinary income in the year of receipt regardless of the Section 1033 election; unrecaptured Section 1250 gain on buildings runs at a maximum federal rate of 25 percent and can be deferred if the election is properly made. Run both before the award closes so the client knows the cash owed whatever they reinvest. Next month builds the full recapture plan; the two calculations are in why § 1245 and § 1250 are not the same number.
Case to watch
Hoffmann v. WBI Energy Transmission, in the United States Supreme Court. A private pipeline company used federally conferred eminent domain power to take land from North Dakota ranchers and left the owners with substantial unanticipated costs. The question before the Court is whether a private holder of a certificate of public convenience can exercise condemnation authority in a way that shifts financial burdens onto owners beyond just compensation. The answer will matter for pipeline corridor cases nationwide and for how just compensation is measured when the condemnor is private.
Working a partial taking that has not closed? A free thirty-minute call with Steve Medendorp looks at the allocation, the appraisal and the reinvestment options before the papers are signed.
