An involuntary conversion, in the tax code’s language, is what happens when property is taken by condemnation, or sold under the threat or imminence of condemnation, and Section 1033 lets the gain be deferred if the owner buys qualifying replacement property in time. The hard question is the second case: when does government pressure to sell become a real threat of condemnation? Johnson v. Commissioner is the Tax Court’s clearest answer, and it gives owners and their attorneys a three-part test and a documentation plan.
The facts of Johnson
The taxpayers in Johnson owned property used for automobile dealerships. After they abandoned a proposed relocation to a competing city, local officials repeatedly told them the city would condemn the property unless they sold it and moved to the city’s auto mall. The redevelopment agency and the city council authorized those statements. The taxpayers sold and acquired similar replacement property. The IRS challenged the Section 1033 treatment. The Tax Court found for the taxpayers.
The three-factor test
The court identified three factors that, taken together, established a qualifying threat of condemnation:
- The condemning body possessed, or could readily obtain, eminent domain authority.
- An authorized government official told the owner that condemnation would be pursued unless a sale or exchange occurred.
- The circumstances gave the owner reasonable grounds to believe the threat was authorized and likely to be carried out.
The court applied an objective standard, from the perspective of a reasonable seller. Repeated statements by multiple officials, authorization by the governing bodies, hostile negotiations, and the taxpayers’ consultation with counsel all supported the conclusion that the threat was genuine. The court also held that the taxpayers’ awareness of favorable tax treatment did not, by itself, make the transaction collusive.
The contrast: 815 Riverside Co. v. Commissioner
In 815 Riverside Co. v. Commissioner (T.C. Memo. 1987-524), the government had the authority to condemn but never seriously contemplated doing so. The taxpayer wanted to sell. Officials did not seriously contemplate condemnation. And, decisively, the taxpayer’s own attorney requested a written condemnation threat for tax purposes. Section 1033 treatment was denied. The contrast with Johnson is sharp: in Johnson the threat was real and came from multiple authorized officials; in 815 Riverside it was manufactured at the taxpayer’s request.
The statute
Under Section 1033(a), gain from property compulsorily or involuntarily converted because of condemnation, or the “threat or imminence” of condemnation, may be deferred if the taxpayer timely purchases qualifying replacement property. For condemned real property held for business or investment, Section 1033(g)(1) applies the like-kind standard, and the replacement period is three years after the close of the first taxable year in which gain is realized. The rules are set out on our 1033 Exchange page.
What Johnson means in practice
For the eminent domain attorney, Johnson establishes that the Section 1033 analysis should begin when the owner first reports pressure from government officials, not when formal proceedings are filed. If the government is making credible threats and the owner is considering a sale, the Section 1033 question is live, and the documentation of those threats starts to matter immediately. That is also the moment the tax planning should start, before anything is signed.
Documentation that supports a Johnson argument
- Record authorized governmental statements as they happen: who said what, when, in what capacity, and with what authority.
- Establish that the condemning body possessed, or could readily obtain, eminent domain authority.
- Record the owner’s contemporaneous belief that the threat was credible and likely to be carried out.
- Document the causal connection between the threat and the decision to sell.
- Retain counsel’s advice contemporaneously.
- Never solicit or request a written threat for tax purposes. It is far more likely to defeat the Section 1033 claim than to support it.
The bottom line
Johnson v. Commissioner sets out a workable, evidence-based framework for deciding whether a sale qualifies as an involuntary conversion under a threat of condemnation. Given how few condemnation cases have been litigated, Johnson carries significant weight. The documentation that supports a Johnson argument should reflect what actually happened: the threats made, the officials identified, the negotiations conducted, the counsel consulted. Not a threat solicited after the fact.
Where a tax specialist fits
We are not the owner’s attorney and we do not negotiate awards. When an owner first reports pressure to sell, we help the owner and the attorney see whether Section 1033 is in play, what to document, and what the basis and the replacement clock would look like if it is. If the owner does not need us, we say so. The first call is free.
Frequently asked questions
What is an involuntary conversion? The tax code’s term for property that is destroyed, stolen, seized, requisitioned or condemned, or sold under the threat or imminence of condemnation. Section 1033 lets the gain on an involuntary conversion be deferred when qualifying replacement property is acquired within the replacement period.
Does a sale under threat of condemnation count as an involuntary conversion? Yes, if the threat is real: the body had condemnation authority, an authorized official said condemnation would follow if the owner did not sell, and a reasonable owner would have believed it. That is the Johnson test.
Can I ask the government for a letter saying it would have condemned? Do not. In 815 Riverside the taxpayer’s attorney requested exactly that letter, and the court denied Section 1033 treatment because of it.
Under pressure to sell before any proceeding is filed? A free thirty-minute call with Steve Medendorp covers what to document now and how the Section 1033 election would work.
