Section 1245 recapture is the number a client owes whatever they reinvest, and last month’s issue drew the line between it and Section 1250. This month is the planning framework, because the distinction is only useful if the work happens before the check arrives. The pattern I see: a client settles, celebrates the result, and six months later gets a tax bill no one priced in. Not because anyone did anything wrong, but because the recapture conversation never happened before closing. If the client does not know the Section 1245 number before the wire hits, every reinvestment decision is being made without knowing the real cash position.
The Section 1245 calculation the IRS expects
When an award includes proceeds for depreciable personal property (machinery, equipment, fencing, irrigation, storage structures), the depreciation claimed on those assets is recaptured as ordinary income in the year the proceeds are received. The Section 1033 election that defers the gain on the real property does not touch it: no election, no deferral, no workaround. Run the calculation before the award closes, not at tax time. It fixes the cash the client owes regardless of reinvestment, and a client who reinvests the whole award and then owes recapture in April has a liquidity problem that could have been avoided. The method and the form: Section 1245 recapture in a condemnation.
Sequencing the Section 1033 election around it
The election defers the gain on the real property piece, but only if qualifying replacement property is acquired within the replacement period, and the client has to decide how much of the award to deploy before the exact Section 1245 liability is known at filing. Reserve the recapture first; elect on the rest. Mixed-property awards add a step: when one award covers both real property and equipment, the allocation between the two belongs in the settlement documents before closing, because it decides which portion can be deferred and which cannot. A single undivided number leaves an ambiguity the IRS resolves against the taxpayer. The seven steps: sequencing the Section 1033 election.
Interest on the award is ordinary income
When a case takes time to resolve, as most do, the authority pays interest from the date of taking to the date of payment. That interest is ordinary income in the year received: not gain from the conversion of property, not deferrable under Section 1033, not excludable. The settlement should identify the interest component separately. With a global number, the IRS may characterize part of it as interest anyway, and the client has nothing to push back with. The article: interest on a condemnation award. Next month: business loss claims in a condemnation, how clients recover for lost profits, and what the IRS requires.
Johnson v. Commissioner: what counts as a threat
Johnson v. Commissioner (T.C. Memo. 1998-448) holds that formal condemnation proceedings are not required for Section 1033 treatment. An oral threat by an authorized government official can suffice, provided the evidence meets an objective standard from the seller’s perspective. The contrast is 815 Riverside Co. v. Commissioner (T.C. Memo. 1987-524): the government had the authority but never seriously contemplated condemning, the taxpayer wanted to sell, and the taxpayer’s own attorney requested a written threat for tax purposes. The court found no genuine threat. Documentation and context matter as much as the threat itself: involuntary conversion under threat of condemnation.
Case to watch
Hoffmann v. WBI Energy Transmission, in the United States Supreme Court. The Court accepted certiorari in August; oral argument has not been scheduled. The question is whether just compensation under the Fifth Amendment must include costs imposed on landowners beyond the value of the property taken. A ruling that broadens just compensation would change how awards are calculated in pipeline corridor and infrastructure cases nationwide.
Have a commercial or income-producing property in condemnation right now? A free thirty-minute call with Steve Medendorp runs the recapture numbers before closing.
