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What you basically have is a condemnation of your property by the DOT. The IRS defines a condemnation as "the process by which private property is legally taken for public use without the owner's consent. The property may be taken by the federal government, a state government, a political subdivision, or a private organization that has the power to legally take it. The owner receives a condemnation award (money or property) in exchange for the property taken. A condemnation is like a forced sale, the owner being the seller and the condemning authority being the buyer."
They are paying you for damage they did plus any property that they are seizing. The IRS calls this an "involuntary conversion". Normally, under IRC §1033, you can defer any gain on the sale or conversion of the property for up to four years, assuming that certain conditions are met. The property must be 1) destroyed because of a casualty (hurricane, earthquake, fire, flood, etc), 2) Lost because of theft, or 3) transferred because of condemnation or the threat of condemnation.
The owner of the property does not have to be concerned about immediate replacement, as he would under an IRC §1031 exchange. Here, the owner has two years or longer to replace the property and defer the gain.
In some instances, only a portion of a property could be involuntarily converted. For example, under the power of eminent domain, a city might take a building owner’s parking lot, but not the building. If the taking of the parking lot renders the operation of the building economically impractical, then the property owner could sell the building as part of the original conversion and defer capital gain from the building sale as well. Known as the Masser Doctrine, thistax court decision allowed for the involuntary conversion of all property within the same economic unit.
In an IRS ruling, the Service stated “[W]here all the facts and circumstances show a substantial economic relationship between the condemned property and the other property sold by the taxpayer, so that together they constituted one economic property unit, such as existed in the Masser case, involuntary conversion treatment for the proceeds of the voluntary sale will be permitted.”
Since the DOT is only taking part of your property and leaving you with part of the property, you have a partial conversion, so the sale of the property for the additional $250k can be linked to the condemnation by the DOT.
Whenever a property is involuntarily converted, it must be replaced within a specific timeline with a property of equal value in order to receive complete tax-deferral. The type of property, and its use at the time of conversion, are important factors in determining how long a taxpayer has to acquire a replacement property, as well as the specific kind of property to be acquired. Additionally, the manner in which it was involuntarily converted (e.g., destruction or condemnation) can narrow the replacement property choices for a taxpayer.
The replacement period starts from the earliest of: a) the date the converted property is disposed of; or b) the date of a threat or imminence of requisition or condemnation. The replacement period ends anywhere from two to four years from the end of the tax-year during which any part of the gain is realized.
For conversions due to condemnation or a sale due to the threat or imminence thereof, there is a three-year replacement period beginning at the end of the tax year the condemnation proceeds are received.
If your property was condemned or disposed of under the threat of condemnation, figure your gain or loss by comparing the adjusted basis of your condemned property with your net condemnation award.
If your net condemnation award is more than the adjusted basis of the condemned property, you have a gain. You can postpone reporting gain from a condemnation if you buy replacement property. If only part of your property is condemned, you can treat the cost of restoring the remaining part to its former usefulness as the cost of replacement property.
If your net condemnation award is less than your adjusted basis, you have a loss. If your loss is from property you held for personal use, you cannot deduct it. You must report any deductible loss in the tax year it happened.
Since your LLC is a single member LLC, it is a disregarded entity, which means that you report transactions as if the LLC did not exist. Therefore, don't worry about any quit claiming back to you. Also, the holding period for long-term capital gains is one year.
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Your adjusted basis is the cost of the property, meaning what you paid for it plus the cost of all improvements, less any depreciation taken.