Technical topics regarding tax preparation.
Taxation of proceeds of contract to not complain........
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19-May-2020 5:10pm

I am trying to determine how to tax the proceeds from a contract to not sue in the future..........no taxation, capital gains, or ordinary income.

Your comments will be appreciated.

Situation........... acreage owner received 45,000 from the power company. The power company is the owner and operator of several wind mills within a five mile radius of the acreage.

The purpose of the payment is to cause the acreage owner to give up his right to sue the wind mills' owner over problems resulting from the wind mills" operations..........such things as discomfort from light flickering from the blades, etc etc.

I have requested a copy of the contract so I can determine wording and length of time.......but am wanting to get started.

My instincts say the amount is taxable as ordinary income.............or, said in a different way------- to tax it otherwise could cause a crap-storm, ending in an audit, which could be beyond the financial capabilities of these taxpayers at this time.

The "screw-the-govt" side of me says, however, that the taxation of the current amount might be not taxable, since the type of recovery (or basis of lawsuit) would be for damages from medical problems, which would PROBABLY be not taxable.

It is conceivable that I am tilting at windmills since the contract might specify an outcome.........but taxpayers were sent a 1099 for rent, so I am guessing that the power company has intentionally/unintentionally set the stage already.

Do I have any basis in using the PROBABLE reason for a future lawsuit for determining the current taxation?

Has anyone handled a similar matter? Any attorneys reading this that have an opinion?

Thanks.

19-May-2020 8:57pm

Possibly a return of capital for damage to value of property (possibly)?


http://www.woodllp.com/Publications/Art ... 120302.htm

20-May-2020 7:35am

Does the inability to sue extend to the next owner of the property - possibly, then, an easement?

I have seen had clients receive 1099s for "rent" in instances where there was a capital gain involved. I wonder if the senders felt they had to send "something" or if they planned on deducting the cost of property rights they had obtained.

20-May-2020 9:44am

I was heading where Henry David went. And I love the writing, esp. the 'tilting at windmills'....many folks here are too drab to catch it. lol....

Anyway, I think it seems more like payment for damages to the value of the property....seeing the contract would help. And if it is for damages, you have a reporting problem with the 1099...

20-May-2020 3:28pm

Lots of good input above.
I'm guessing:
The contract is in perpetuiy and is probably recorded in county property records and carries to later owners.
The power co. is big enough to have had pretty good legal input about:
Tax effect to them
Tax effect to owner of land
Legal aspects other than tax
Immediate rent deduction by them seems out of the question.
Rent income to owner seems wrong as they are not renting anything.
Return of capital to the extent of basis seems correct to me.
Capital or 1231 gain if 45,000 exceeds basis.
Some sort of in and out treatment that you preparers know how to present to avoid IRS correspondence.
Consider disclosure to avoid penalty exposure.
Don't see merit to OP ideaof associating it with possible future medical expenses.
Not sure that "easement is the proper legal term; more an encumbrance on the deed.

20-May-2020 6:40pm

If attached to property has to be treated as easement. Otherwise I would vote for tort settlement.

20-May-2020 7:19pm

Read section 104.
"Tort" settlements - assuming this could qualify as a tort settlement - are not necessarily untaxed.
Damages for personal/physical injuries are not taxable.
But it would be hard to construe this as more than damages for emotional distress.

20-May-2020 8:16pm

The tort, if any, is the damage to the value of the property.

20-May-2020 8:47pm

Which would be taxable, correct?

20-May-2020 9:13pm

I see it as a reduction of basis in the property.

Maria U. Ku, CPA
Oakland, CA

21-May-2020 12:02am

Dennis2 wrote:If attached to property has to be treated as easement. Otherwise I would vote for tort settlement.


My take - As an easement the proceeds would be on a 1099-S and assuming sufficient basis to offset that it would result in zero gain. The existence of those windmills apparently did reduce the value of the property. Tax impact on the payer would seem to be the same as their calling it rental. Maybe the payer needs to file a corrected 1099-Misc and a 1099-S. Years ago I had a situation where a city paid for a easement to run a sewer line. Initially they reported the payment as 1099-Misc, Other Income. I convinced them to change that to an 1099-S.

21-May-2020 5:42am

Return of capital to the extent of basis seems correct to me.

That’s also the conclusion in Post #2. But I got to reading that linked article, which said:

Where a recovery compensates a plaintiff for injuries to a capital asset, the recovery constitutes a tax free return of capital to the extent of the taxpayer's basis in the injured asset.

That article also said a bunch of other stuff…

And then I referred back to OP, which said these things:

The power company is the owner and operator of several wind mills within a five mile radius of the acreage.

such things as discomfort from light flickering from the blades, etc etc.

And then I got to wondering if one’s optic nerve and/or his eyeballs and/or his psyche really are capital assets…

21-May-2020 8:15am

Jeff-Ohio wrote:And then I got to wondering if one’s optic nerve and/or his eyeballs and/or his psyche really are capital assets…


It depends if a human being is property. If yes, go to §1221.

21-May-2020 8:36am

Jeff-O is thinking pretty deeply here. Damage to optic nerves etc.

Isn't this situation similar to a land owner's granting an easement (if that's the right characterization of the contract) to a municipality or state or even a group of neighboring owners in which the land is in perpetuity encumbered with an obligation not to build anything oon it that would obstruct a view? Aren't those called conservation easements or something? With known tax results?

21-May-2020 11:24am

Isn't this situation similar to a land owner's granting an easement (if that's the right characterization of the contract) to a municipality or state or even a group of neighboring owners in which the land is in perpetuity encumbered with an obligation not to build anything oon it that would obstruct a view?


Don’t know. We were told client is being compensation for potential issues surrounding the operation of Power Company windmills located in surrounding areas.

OP describes one such issue as “light flickering from the blades.” I don’t think he’s talking about lights inside of client’s home that might flicker owing to power disruptions caused by the windmills. I think he’s talking about sunlight hitting a windmill blade, wherein sunlight is redirected into client’s eyeballs. If so, I don’t see how this pertains to client’s real property.

OP also says, “etc etc.”

I wonder what those “etc’s” encompass. I’m also wondering why OP used two “etc’s” instead of one or three.

21-May-2020 11:39am

J-O is having fun with y'all now....for the humorless among you.

21-May-2020 12:28pm

I proudly count myself in the humorless group. Not so much because I'm humorless, but because my jokes almost always fall flat.

I don't bet, but if I bet, I'd bet the contract will relate to the possible decrease in land value, plus maybe 1 or 2 etc.'s.
Last edited by Nilodop on 21-May-2020 2:21pm, edited 1 time in total.

21-May-2020 1:27pm

Exactly. No different than the county building a highway off the back of your property. Or a skyscraper going up that blocks the sun...etc.

21-May-2020 3:39pm

Humor aside, my understanding of the effects of wind turbines on adjacent properties is that there have been complaints of “ice throws,” interference with TV and radio signals, bird deaths, and adverse health effects such as headaches and sleeplessness caused by the noise that the wind turbines make, and “shadow flicker” from the sun passing through the moving blades, similar to a strobe effect.

These problems have nothing to do with the homeowners’ land, so it seems like it would be a stretch to say that the $45,000 from the power company is return of capital for damage done to the property.

And unless the $45,000 is specifically stated to compensate the adjacent property owner for physical injuries suffered as a result of the effects of the wind turbines, the $45,000 wouldn’t be excludable under 104(a)(2). See the 2nd test of Schleier, 515 U.S. 323 (1995).

21-May-2020 6:38pm

While they may have nothing to do with the homeowner's land, they certainly may have something to do with the value of said land ...
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