We will be hearing a lot about infrastructure upgrades for the foreseeable future. President Trump campaigned on a massive infrastructure package and Senate Democrats have already unveiled a $1 trillion infrastructure bill. Residents of north-central Indiana have seen infrastructure spending up close and personal over the last decade. Infrastructure improvements such as the US 31 project, Wildcat Wind Farms, new cell phone towers, and upgraded transmission towers continue to change the landscape and impact property owners.
Many agree this type of progress is necessary and good for the economy – until the project runs through their backyard and they are forced to give up their land.
Once a project is approved by state and local authorities, land owners have no choice but to relinquish their property. In an attempt to soften the blow, agencies generally pay a premium for the land.
This helps until the property owner starts to wonder about the possible income tax liability. The terms of the transaction will determine the nature and amount of income tax assessed.
For example, if you enter into a lease to have a cell phone tower put on your property, proceeds will be subject to ordinary income tax rates.
If your property was taken under threat of eminent domain, or you sold the perpetual right to use the land, the transaction will be subject to the favorable capital gains tax rules. The difference between ordinary income tax rates and capital gains tax rates is often significant.
However, just because you were forced to give up your property doesn’t mean you are forced to pay tax. Federal tax elections exist that may allow you to postpone reporting gain on property involuntarily taken.
Taxpayers who voluntarily sell real estate generally have the opportunity to reinvest the proceeds and defer paying income tax on the gain. Internal Revenue Code (IRC) Section 1033, Involuntary Conversions, was enacted to allow taxpayers being forced to sell their property a similar opportunity.
The following examples illustrate potential tax implications arising from 3 different types of infrastructure related transactions.
Brad owns farmland and is approached by a Wireless provider looking to build a new cell tower in the area. An agreement is reached to lease a portion of the land for 10 years at $15,000 per year. Proceeds received will be subject to ordinary income tax rates. Currently, the maximum federal rate is 39.6%.
Kyle owns farmland along US 31. The State of Indiana needs 5 acres to build an exit ramp. Exercising its power of eminent domain, Indiana buys the land from Kyle for $150,000. Kyle realizes a long-term capital gain of $115,000 ($150,000 proceeds less cost basis of $2,000/acre and selling costs of $25,000). If Kyle desires to keep the proceeds instead of finding replacement property, he will recognize gain and pay tax at the applicable capital gains tax rate (0%/15%/20%) in the year proceeds are received.
Andy owns farmland in Cass County. In 2016 NIPSCO, by eminent domain, pays $150,000 for the perpetual right to use 5 acres for its new transmission towers. Andy realizes a long-term capital gain of $115,000 ($150,000 proceeds less cost basis of $2,000/acre and selling costs of $25,000). However, by making an IRC Section 1033 election with his 2016 income tax return, Andy will postpone recognizing gain and must now find qualified replacement property within the replacement period. Replacement property is purchased in 2017 for $160,000. The entire gain of $115,000 is postponed and Andy’s basis in the new land is $45,000.
If you are a landowner whose property is in the path of an infrastructure project, you have likely consulted with an attorney. Make sure you also contact a CPA knowledgeable about involuntary conversions. BMM understands the nuances involved and will help you navigate this often misunderstood area of tax law. Contact one of our offices so we can share our expertise with you.