Minimizing gain from involuntary conversions.

• Author: Ellentuck, Albert B.

Facts

Julie owned several warehouses. The city wanted to build a park on the site of these warehouses. Instead of letting the property be condemned, Julie sold it to the city for $275,000 in 1991.

Julie's adjusted basis in the warehouses and land was $137,000. Julie wants to use the sales proceeds to purchase another parcel of land to hold for investment but is concerned about the $138,000 gain.

Issue

Must Julie recognize the gain from the sale to the city?

Analysis

Generally, a taxpayer must recognize gain from the sale of assets in the year of the sale. However, the taxpayer does not always have to recognize gain realized from an involuntary conversion. If the taxpayer converts property directly into qualified property, nonrecognition of gain is mandatory. If the taxpayer receives cash or nonqualified property for the converted property, the taxpayer can elect to not recognize the gain if the convened property is replaced with qualified property within the replacement period. In either case, the gain is deferred, not excluded. Involuntary conversions: Involuntary conversions include the conversion of property because of whole or partial destruction, theft, seizure, requisition or condemnation, or sales arising from the threat or imminence of requisition or condemnation.

The sale of property is considered involuntary only if the sale occurred as a result of the threat or imminence of requisition or condemnation. The taxpayer must have received oral or written notice that a governmental body or authorized public official intends to acquire the property. Additionally, the taxpayer must have reasonable grounds to believe the property will be condemned if not voluntarily sold.

Julie's sale arose from the threat of condemnation. Thus, if she purchases qualified property within the replacement period, she can elect to defer the gain. Qualified property: Generally, the property replacing the converted property must be "similar or related in service or use." Although the new assets do not have to duplicate the converted assets, they must be substantially similar.

Special rules apply to the seizure, condemnation or threat of condemnation of real property used in a trade or business or held for investment (but not held primarily for sale); the replacement property need only be of "like kind." This like-kind requirement is the same as that for Sec. 1031 exchanges. Thus, unimproved real estate could be...