18.25 Special Assessments and Severance Damages

When only part of a property parcel is condemned for a public improvement, the condemning authority may:

1. Levy a special assessment against the remaining property, claiming that it is benefitted by the improvement. The authority usually deducts the assessment from the condemnation award.
2. Grant an award for severance damages if the condemnation of part of your property causes a loss in value or damage to the remaining property that you keep.

Special assessments reduce the amount of the gross condemnation award. If they exceed the award, the excess is added to the basis of the property. An assessment levied after the award is made may not be deducted from the award.

EXAMPLE
Two acres of a 10-acre tract are condemned for a new highway. The adjusted basis of the land is $30,000, or $3,000 per acre. The condemnation award is $10,500; you incurred expenses of $500 to get the award. The special assessment against the remaining eight acres is $2,500. The net gain on the condemnation is $1,500:
Condemnation award minus your expenses $10,000
    Less:
Basis of two condemned acres $6,000
Special assessment   2,500     8,500
Net gain   $1,500

When both the condemnation award and severance damages are received, the condemnation is treated as two separate involuntary conversions: (1) A conversion of the condemned land. Here, the condemnation award is applied against the basis of the condemned land to determine gain or loss on its conversion; and (2) a conversion of part of the remaining land in the sense that its utility has been reduced by condemnation, for which severance damages are paid.

Net severance damages reduce the basis of the retained property. Net severance damages are the total severance damages, reduced by expenses in obtaining the damages and by any special assessment withheld from the condemnation award. If the damages exceed basis, gain is realized. Tax may be deferred on the gain through the purchase of replacement property under the “similar or related in service or use” test (18.23), such as adjacent land or restoration of the property to its original condition.

Allocating the proceeds between the condemnation award and severance damages will either reduce the gain or increase the loss realized on the condemned land. The IRS will allow such a division only when the condemnation authority specifically identifies part of the award as severance damage in the contract or in an itemized statement or closing sheet. The Tax Court, however, has allowed an allocation in the absence of earmarking where the state considered severance damages, and the value of the condemned land was small in comparison to the damages suffered by the remaining property. To avoid a dispute with the IRS, make sure the authority makes this breakdown. Without such identification, the IRS will treat the entire proceeds as consideration for the condemned property.

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