1033 exchange replacement property after a partial taking does not have to be the land the owner kept. When severance damages exceed the basis of the retained parcel, the excess is gain, and Rev. Rul. 83-49 holds that the gain can be deferred under Section 1033 by reinvesting in any qualifying replacement property. For condemned business or investment real estate, “qualifying” means the like-kind standard, which is nearly any real property held for business or investment, anywhere in the country. The owner is not required to restore the retained parcel, improve it, or even keep it.
The problem: severance damages that exceed basis
Severance damages first reduce the adjusted basis of the retained parcel. If the damages are less than or equal to that basis, the owner recognizes no gain; the basis is simply reduced. When the damages exceed the basis, the excess is gain in the year of receipt. That is where Rev. Rul. 80-184 comes in: it confirms that the excess triggers gain, and it does not say that the gain cannot be deferred.
Rev. Rul. 83-49 picks up where 80-184 leaves off. It holds that severance damages which exceed the basis of the retained parcel can be deferred under Section 1033 by reinvesting in qualifying replacement property, without any requirement to restore the retained parcel itself. How the allocation to severance damages is negotiated in the first place is covered in our article on severance damages in eminent domain.
What this means in practice
Under the general Section 1033 standard, replacement property must be “similar or related in service or use” to the condemned property, a relatively strict test. For condemned business and investment real estate under Section 1033(g), the standard drops to the same like-kind test used in 1031 exchanges. Any real property held for business or investment qualifies: commercial buildings, raw land, multifamily residential, industrial property, or real estate in another state.
Applied to severance damages under Rev. Rul. 83-49, an owner whose retained remainder has low or zero basis, and who receives severance damages that produce a gain, can defer that gain by investing in entirely different replacement property. The full rules on what qualifies are on our 1033 Exchange page.
The two rulings, read together
Rev. Rul. 80-184 and Rev. Rul. 83-49 address different parts of the same problem and belong together.
Rev. Rul. 80-184 says when gain is triggered. Severance damages that reduce the retained parcel’s basis to zero create a gain event for the excess received, recognized in the year of receipt.
Rev. Rul. 83-49 says how to defer it. The excess gain can be deferred under Section 1033 by reinvesting in qualifying replacement property within the replacement period. The replacement property does not need to be the retained parcel; any like-kind property held for business or investment qualifies under Section 1033(g).
The replacement period
The replacement clock follows the standard Section 1033 rules. For most assets the period is two years from the end of the first taxable year in which any part of the gain is realized. For condemned business or investment real estate under Section 1033(g), it extends to three years. The Section 1033 election is made on a timely filed return for the year in which the gain is first realized.
Advance purchase is also available. If the owner identifies and acquires qualifying replacement property before the condemnation proceeds arrive, but after the threat of condemnation was first communicated, that property counts toward the replacement requirement. This is a real advantage over Section 1031, which requires the exchange to follow the disposition.
Who this helps most
Rev. Rul. 83-49 matters most to owners with little or no remaining basis in the retained parcel, a common situation when the property has been held for many years and depreciated substantially. It also matters to owners who have no interest in continuing to use or hold the retained parcel after the taking, because it gives them full flexibility to redirect the severance proceeds into a different investment.
If an owner is in a partial taking, knows the retained parcel has a low basis, and is asking what can be done with the severance damages, this is the answer.
Where a tax specialist fits
We are not the owner’s attorney and we do not negotiate awards. We calculate the retained parcel’s basis, identify the gain the severance damages will produce, and map that gain to qualifying replacement property inside the replacement period, with the owner’s CPA. If the owner does not need us, we say so. The first call is free.
Frequently asked questions
What qualifies as replacement property under Section 1033? For condemned real property held for business or investment, any like-kind real property under Section 1033(g): commercial, residential rental, raw land, industrial, in any state. For other property, the stricter “similar or related in service or use” test applies.
Do I have to rebuild on the land I kept? No. Under Rev. Rul. 83-49, gain from severance damages above basis can be deferred into any qualifying replacement property; restoring the retained parcel is not required.
How long is the replacement period? Three years after the close of the first taxable year in which any part of the gain is realized, for condemned business or investment real estate; two years for most other property.
Low basis in the land you are keeping? A free thirty-minute call with Steve Medendorp maps the severance damages to replacement property before the replacement clock runs.
