What part of just compensation is taxed is the question I hear most from attorneys with a commercial client heading into settlement. The answer depends on which component of the award you are looking at, and this month covers the four business loss categories that catch clients off guard: lost profits, goodwill, relocation costs, and equipment damages. Each is compensable in many states, each is taxed differently, and the moves that decide how much of the recovery the client keeps are made before the settlement is signed.
Lost profits are ordinary income, and the election does not reach them
When a condemnation takes a commercial property and the business suffers lost profits, the compensation for those profits is ordinary income in the year of receipt. It is not a gain on property, so the Section 1033 election does not defer it, and reinvesting the money in replacement property does not change its character. The client who treats lost profits as part of the reinvestable award will owe tax on them at filing with nothing set aside. The full article explains why the IRS treats them as a substitute for income: business damages in eminent domain.
Goodwill can come back tax-free, if the facts are in place first
In states that compensate for loss of goodwill, the tax result turns on whether the goodwill was personal to the owner or belonged to the enterprise. Personal goodwill that cannot be transferred with the business is generally a return of a capital asset, not income. That outcome depends on facts documented before the settlement closes, not reconstructed afterward. The article walks through the distinction and what the tax team needs: eminent domain compensation examples for goodwill.
Relocation reimbursements are tax-free when federal money is in the project
Under the Uniform Relocation Act, a federally funded condemning authority reimburses a displaced business for moving, re-establishment, and search costs, and those reimbursements are excluded from income by statute. A purely state, local, or private taking does not carry the exclusion, and the same reimbursements become taxable. The funding source is the first question to ask. The article covers what qualifies and what does not: eminent domain compensation for relocation.
Equipment runs through Section 1245 before anything else
Money received for business equipment in a taking is a return of basis first, then ordinary income up to the depreciation already claimed, and only rarely capital gain. The ordinary income piece cannot be deferred. Inventory is ordinary income from the first dollar above cost. A global settlement figure, without an itemized breakdown, leaves the tax team room to characterize each component in the most favorable supportable way. The article lays out the framework: the involuntary conversion tax on equipment.
Case to watch: Hoffmann v. WBI Energy Transmission
The Supreme Court has granted certiorari in Hoffmann v. WBI Energy Transmission; oral argument is not yet scheduled. The question before the Court is whether just compensation under the Fifth Amendment must account for costs imposed on landowners beyond the fair market value of the property taken. For a pipeline or infrastructure file, a ruling that widens the framework would change what the award contains, and therefore what part of it is taxed.
Is there a business on the property being taken this month? A free thirty-minute call with Steve Medendorp sorts the four categories before the settlement closes.
