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Taxation of proceeds of contract to not complain........

Technical topics regarding tax preparation.
#1
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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.
 

#2
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Possibly a return of capital for damage to value of property (possibly)?


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

#3
MWPXYZ  
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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.
 

#4
JR1  
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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...
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#5
Nilodop  
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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.
 

#6
Dennis2  
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If attached to property has to be treated as easement. Otherwise I would vote for tort settlement.
 

#7
keiser  
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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.
 

#8
Nilodop  
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The tort, if any, is the damage to the value of the property.
 

#9
keiser  
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Which would be taxable, correct?
 

#10
mariaku  
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I see it as a reduction of basis in the property.

Maria U. Ku, CPA
Oakland, CA
 

#11
Jake  
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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.
 

#12
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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…
 

#13
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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.
 

#14
Nilodop  
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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?
 

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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.
 

#16
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J-O is having fun with y'all now....for the humorless among you.
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#17
Nilodop  
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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.
 

#18
JR1  
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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.
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#19
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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).
 

#20
Webster  
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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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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.


The problem with that logic, based on what we know, is that some of the potential “injuries” don’t *just* devalue the property. They might also cause personal discomfort…especially the one that OP has cited, about all that flickering.

Picture This: It’s 3pm on Tuesday and you just sat down in front of your TV to watch your favorite show, The Tax Show, on Channel 1221. Every 2-seconds a flicker of light comes through the window. What an annoyance! In legal jargon, I might label it a “Nuisance.”

While that flicker might reduce the market value of my home, I’d also want to be paid for my personal discomfort. I have a Right-to-Light, right?
 

#22
keiser  
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Many people mistakenly assume that "tort" damages are not taxable.
This is not true. Read section 104.
Compensation for emotional distress is taxable.
Compensation for physical injuries are not taxable.
Rather than speculate what was purportedly compensated, a copy of the contract would help.
 

#23
Dennis2  
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Further thoughts suggest that any loss in property value occurred when windmill company got approval to build.
 

#24
Nilodop  
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Maybe but the 45000 dollars happened now.
 

#25
Dennis2  
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irrelevant. Company can't have liability for value decline. System doesn't work that way. All sorts of hoops in application process where property owner can be bought off to shut up, but after actual construction game over.
 

#26
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Keiser, I would like to say you’re on a roll, but, as to these comments…

Compensation for emotional distress is taxable.
Compensation for physical injuries are not taxable

…the actual language in Sec 104 is “on account of” (not “for”). So, it is quite possible that someone who sustains a physical injury and because of that, also suffers emotional distress, might get an award that covers all of that stuff and all of it would indeed be excludible. In fact, someone might sustain a physical injury, and a mere onlooker, who witnesses the injury, might himself suffer from emotional distress. If that onlooker receives a sum for his distress, it too would be “on account of” a physical injury, even though it was not his own physical injury.
 

#27
keiser  
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Barbato, TC Memo 2016-23 provides a recent discussion of taxablity of pure emotional distress damages.
 

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Barbato, TC Memo 2016-23 provides a recent discussion of taxablity of pure emotional distress damages.

Key word being “pure,” meaning there was no correlative physical injury. There’s hundreds of cases like this one…and maybe this case is why postage prices keep going up!
 

#29
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Jeff, you make a valid point.
Not all jurisdictions allow recoveries for emotional distress to bystanders.
For such jurisdictions, a 2018 Law Review says: "It is not clear whether damages would be excluded in bystander claims where the link between the damages and the physical injury is more tenuous. For example, in California a plaintiff may recover for the emotional disturbance of witnessing an accident that causes physical harm to a close relative. Arguably, such a claim is "an action [that] has its origin in a physical injury" and the damages "flow therefrom," as required by the legislative history quoted above. However, there are no tax cases or rulings that address this specific situation." 22 Fla. Tax Rev. 120, 126 (2018-2019) Taxing Litigation: Federal Tax Concerns of Personal Injury Plaintiffs and Their Lawyers.
Who knows what the contract actually purports to compensate?
 

#30
Nilodop  
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The Shadow knows. And jakescia.
 

#31
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My conclusion..........

I finally received a copy of the agreement. Such is labeled "(Wind mill owner) Neighbor Easement Agreement".

Pertinent item..........Grant of Effects, Sound and Shadow Easements. Owner hereby grants and conveys to Developer an exclusive easement on, over, and across all of the Owner's Property to permit (Wind Tower) and other project facilities on adjacent property or elsewhere to: cast shadows or flicker onto the Owners Property, cause or emit noise, cause air turbulence, and to cast light from the FAA required lighting and also safety and security lighting relating to the Project (collectively the "Easements".

Length of time.........40 years.

Applies to successors.

My determination re taxes.............return of basis, applied against entire property. Excess over cost is capital gain.

Rev Rul 59-121, as clarified by 68-291.

The court cases I read for pipeline easements indicated that the basis of the land is allocated to the area of the easement. In the case of a pipeline, that easement area would be, say, 100ft wide by length of run.

In this case, since the easement is on the whole property, then the entire property's basis would be available to absorb the easement proceeds.

Being a non-attorney, it took me a little time to absorb the concept that the "easement" was on the property, but really prevented the occupant from hollering foul, since the nuisance items were allowed to be there by contract.....hence the client's description of the agreement being one of preventing him from suing.

In addition, to me the contract/easement makes a big deal of the easement running with the property. Looking at an illogical but possible situation--------I wonder if that would mean that the land owner could buy additional property "up the road", which is not covered by any easement at time of purchase, change his residence to that property (ie establishing residence so that there would be ample time to show the long-term effects of damage from such items as the "light flickering from the blades"), and sue for the effects of "light flickering" etc etc, without being bound by the easement.

In summary, after vacating the "personal injury" concept...........the conclusion became relatively obvious.

Thanks, All.
 

#32
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Apparently the wind mill owner knows what evil lurks in the hearts of men too!
 

#33
Nilodop  
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As to your paragraph about the possible but illogical situation, wouldn't you expect that the power co. obtained similar easements on all the surrounding properties that might be affected?

To me the intriguing thing is the 40-year duration of the easement. Maybe there's case law to the effect that after that amount of time, any buyer of the affected property should know what he's buying, including the flicker, etc.

But as to the tax result, maybe I'm just connecting OP's facts with deducting a conservation easement, the latter requiring that the easement be perpetual. Maybe that's where the rental notion comes in. Anyone feel like looking up the legislative or rgulatory discussion as to why the consrvation easement has to be perpetual?

(5) Exclusively for conservation purposesFor purposes of this subsection—
(A) Conservation purpose must be protected
A contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.


(2) Qualified real property interestFor purposes of this subsection, the term “qualified real property interest” means any of the following interests in real property:
(A) the entire interest of the donor other than a qualified mineral interest,
(B) a remainder interest, and
(C) a restriction (granted in perpetuity) on the use which may be made of the real property.


Or why this provision exists.

(3) Denial of deduction in case of certain contributions of partial interests in property
(A) In general
In the case of a contribution (not made by a transfer in trust) of an interest in property which consists of less than the taxpayer’s entire interest in such property, a deduction shall be allowed under this section only to the extent that the value of the interest contributed would be allowable as a deduction under this section if such interest had been transferred in trust. For purposes of this subparagraph, a contribution by a taxpayer of the right to use property shall be treated as a contribution of less than the taxpayer’s entire interest in such property.
 

#34
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"As to your paragraph about the possible but illogical situation, wouldn't you expect that the power co. obtained similar easements on all the surrounding properties that might be affected?"

Nilodop, that is why I suggested "illogical".

But, given the farmers I typically deal with, it is not so "illogical" that one within "the affected area" might not be a holdout---------"just because".

And then, "reasonable distance from the offending windmill" would likely be a court-contentious topic also.......
 

#35
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The conservation easements language relates to charitable donations, not easements in this context. The IRS really doesn't like "syndicated" easements, and the regulations have been built around that where donations of building facades, swampland, old mines, etc. are extremely aggressive (and frankly over-valued most of the time). Perpetuity is required to meet the gift standard; likely no application in this context with an easement provided to a windmill owner.

Unless the windmill owner is a non-profit...then a whole other can of worms.
 

#36
keiser  
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The easement "runs with the land" meaning that it transfers with any sale.

The easement is for the utility, not for conservation purposes, so I am not seeing why those sections would apply.

Per Pub 544:

Easement.
The amount received for granting an easement is subtracted from the basis of the property. If only a specific part of the entire tract of property is affected by the easement, only the basis of that part is reduced by the amount received. If it is impossible or impractical to separate the basis of the part of the property on which the easement is granted, the basis of the whole property is reduced by the amount received.

Any amount received that is more than the basis to be reduced is a taxable gain. The transaction is reported as a sale of property.

If you transfer a perpetual easement for consideration and do not keep any beneficial interest in the part of the property affected by the easement, the transaction will be treated as a sale of property. However, if you make a qualified conservation contribution of a restriction or easement granted in perpetuity, it is treated as a charitable contribution and not a sale or exchange, even though you keep a beneficial interest in the property affected by the easement.

If you grant an easement on your property (for example, a right-of-way over it) under condemnation or threat of condemnation, you are considered to have made a forced sale, even though you keep the legal title. Although you figure gain or loss on the easement in the same way as a sale of property, the gain or loss is treated as a gain or loss from a condemnation. See Gain or Loss From Condemnations, later.
 

#37
Nilodop  
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HenryDavid and keiser, I am aware of all you say, but I don't see where you've addressed my point. If the easemtn is less than perpetual, such as 40 years, is it a sle of property or is it akin to prepaid rent?
 

#38
Nilodop  
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This article by Mitch is interesting bit cites no authorities. https://www.bergankdv.com/resources/blo ... -of-way-2/

Temporary easements are generally treated as rental income, whereas perpetual easements involve a permanent impact to the land and thus are treated as an outright sale.


Examples of fixed-term easements which are reported as ordinary income or rent treatment include:

Coal mining surface rights granted under a 35 year easement.
Conveyance of easement limited to period required to remove minerals.
Easement right to use a road for ten year contractual period.


There are situations where long-term leasehold (easement) interests are treated as the equivalent of a real property interest:

Like-kind exchange regulations allow a leasehold interest of 30 or more years, to be eligible for exchange treatment.
In the information reporting requirements, regulations provide that a leasehold, easement or timeshare of a term of at least 30 years is subject to reporting as the gross proceeds from real estate transactions on Schedule 1099-S.
. Someone look this up. Maybe it's authority to say the 1099 for rent is incorrect.
 

#39
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Maybe that's where the rental notion comes in.

I was thinking the same thing when I saw the 40-year life. Some of these cases involve a permanent easement (basis reduction) vs. something less than permanent, which would be a lease.

Here’s a treatise on the conservation easements:

https://www.landcan.org/pdfs/perpetualisnotforever.pdf
 

#40
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From a 12/2019 blog [https://www.wipfli.com/insights/blogs/ag-conversations/tax-sale-of-easement-tax-treatment-income-tax-ramifications], the issue may be unresolved:

"Sale of easement tax treatment
You probably know you’re required to report the sale of an easement for income tax purposes. If you’re granting the easement to a qualifying charitable organization, you can trigger a charitable deduction. But let’s focus on the other option, which is selling the easement, and go over some tax planning strategies.

It will depend on whether the easement is temporary or permanent.

Temporary easements exist only for a limited number of years. They are treated as rent or lease income.

Permanent easements are perpetual or don’t have a specified end date. They are treated as a property sale. This means you can treat the easement as a sale, which has multiple advantages:

The cost basis of the affected land can offset the sale amount. This reduces the income taxes on the deal.
Generally, the income will be taxed at favorable capital gains tax rates.
The sale could qualify for like kind exchange treatment.

IRS regulations allow the sale of a leasehold interest of 30 years of more to qualify for like kind exchange treatment. This causes a dilemma, however, because there is no authority to treat easements of this duration as a sale for tax calculation purposes. If the sale of a 30-year leasehold qualifies as a sale for like kind exchange purposes, then why would it not qualify for cost basis offset and capital gain treatment?

As the frequency of significant easements continues to grow, I suspect that the IRS and the courts will provide guidance in this area."
 

#41
Nilodop  
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Jeff-O, I have neither scanned nor perused that treatise, but I noticed a major theme of it seems to be that perpetual may not really be perpetual. Or something like that.

But the legislative and regulatory history I hoped someone would review is why the conservation easement deduction requires the easement to be perpetual. Was it fiscal (revenue considerations), or political, or technical (substantively different tax aspects of a peretual easemnt and a non-perpetual one). I hope someone looks at that.
 

#42
MWPXYZ  
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This is just from memory, but I believe the exclusive use for conservation purposes requires "protection of the properties" in the easement in perpetuity. But, you do get a deduction for donating a mere partial interest.

Reg 1.170A-14 makes for fascinating reading as do the Tax court cases. There are enough legal issues involved to make the subject matter akin to estates and trusts.
 

#43
Nilodop  
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There's little doubt that a 40-year easement is a property right, even if it's taxed as a lease under tax law, so the earlier emphasis on that may well be misplaced. Or at least not key to our issue (rent vs. sale).

This typically does not happen, but suppose it does: Landowner agrees on a lease for a long number of years (30, 40, 99, maybe just 10 or 15) at a rent amount that is discounted for two factors in return for a prepayment of the entire rent for the term of the lease One factor is the cost of money, i.e., the interest income that the owner expects to earn on the cash received, which upon negotiation is the same as the interest cost the lessee expects to pay. The other factor is the combo of less risk of bad debt loss during the lease and added opportunity for using the advance rent for the owner, with the contra to the lessee. Inflation predictions enter the picture too.

Now suppose the property values and therefore the fair rent values rise rapidly and greatly after the lease is signed. The lessee made a good deal, and the owner/lessor didn't. In fact the value of the property will have declined while the lease is in place, and the owner would have to take a lower price or buy out the lessee if he wanted to sell the property.

Let's say the value decline from the too-low-rental lease happened almost right away But that value change is temporary, and it's well settled that a temporary decline in value of property is not deductible absent some event such as a sale or abandonment. So the owner can't deduct that loss of value. The lease is property but that temporary loss in value not only is not deductible, but it is also not added to basis of the property. If it were, then maybe the advance rent received could be recharacterized as compensation for the loss in value, i'e', a sale of the property.

And if that lease were perpetual (is there such a thing?), I think the whole transaction including the advance rent payment would be viewed as a sale of the property. In fact, any years ago, a client of mine sold a strip mall at a combo of a fixed up front amount, essentially the approximate FMV of the property, plus a perpetual obligation to pay a percentage of the retail sales of the stores in the strip mall (a typical rent override). We concluded that there was a sale of the property at a contingent price on the installment method, with imputed interest under sec 483.

So with that long-winded intro, my point is that a perpetual easement is tantamount to a sale of the part of the property subject to the easement, whereas a temporary easement is analogous to a lease. The tax treatment should follow. Rent.
 

#44
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If rent - would a cash-basis taxpayer have to (or be allowed to) apply 467-type rules and amortize the one-time payment over the life of the lease?
 

#45
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Not sure because we'd have to apply all the tests. But whether the income gets spread out over the term of the lease, or taxed up front under reg. 1.61-8, if it's rent it's not applied to basis.
 

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So with that long-winded intro, my point is that a perpetual easement is tantamount to a sale of the part of the property subject to the easement, whereas a temporary easement is analogous to a lease. The tax treatment should follow. Rent.


So, where does the concept of a “mere” basis reduction come into play? It wouldn’t come into play with a temporary easement (since that’s a lease). It would only come into play only with a perpetual easement…and, it seems, only in limited situations, depending on the nature of the easement. What would one of those situations be?
 

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Not clear why you raise "mere" basis reduction, with or without the quotation marks.

But I'll take a stab at your last question. RR 68-291 and Inaja Land.
 

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Not clear why you raise "mere" basis reduction, with or without the quotation marks.

Because there’s this idea floating out there that if we have a permanent easement, we might just be able to offset the proceeds against our basis and we stop the accounting there. Let’s say basis is $100k and permanent easement payment is $30k. We offset. That’s it. A “mere” basis reduction. No loss recognition. Perhaps this is accurate, since we still retain the property (a la the Open Transaction doctrine). And if the easement payment was $110k, we still don’t have a sale, yet we have $10k of gain to report. (This reminds me of the S-shareholder who hasn’t disposed of his stock, but has a gain for a distribution in excess of basis).

However, in Post #43, you said:

So with that long-winded intro, my point is that a perpetual easement is tantamount to a sale of the part of the property subject to the easement, whereas a temporary easement is analogous to a lease. The tax treatment should follow.

If we have something “tantamount” to a sale, although not a sale, wouldn’t we maybe have gain OR loss recognition?

It seems that the Rule here is this: If we have a permanent easement and retain the property, we can maybe recognize gain, but never loss. That’s not how a sale works. Yes, perhaps that’s how something “tantamount” to a sale works, but that’s only because we attach the word “tantamount” to the transaction after we determine we have a gain. In other words, if we receive a payment for a permanent easement, and we retain the property, we wouldn’t say we should treat the transaction as “tantamount” to sale if the proceeds are less than our basis. In that case, we simply offset proceeds against basis and do not recognize loss. Only if the proceeds exceed basis would we say the transaction is “tantamount” to a sale.

Thank you.
 

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OK, so say using an Inaja reasoning, except we have a 10,000 sq ft unimproved square lot on which every single sq ft has a $10 basis and a $6 value. It's an investment property. We grant a perpetual easement on 2,500 of those sq ft, perhaps all along one side, though that's unimportant. We receive $5 per sq ft or $12,500 for the easement. Unlike in Inaja, we easily and correctly know the basis of the easement land, $25,000, and since we have, per you, an economic but not deductible loss, we must have a remaining basis of $87,500. Had we been able to subdivide and sell the easement land, we'd have had a deductible loss of $12,500 and a remaining basis of $75,000. Please check my math and my understanding of what you taught us.

Now change just one fact - we grant a perpetual easement on the entire property. Above I said And if that lease were perpetual (is there such a thing?), I think the whole transaction including the advance rent payment would be viewed as a sale of the property.. I ask also, is it possible to have a perpetual easement on an entire property and would that, like the perpetual lease, be treated as a sale? With a deductible loss? If so, why no deductible loss on the perpetual easement in my example?

You're welcome.
 

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I ask also, is it possible to have a perpetual easement on an entire property and would that, like the perpetual lease, be treated as a sale? With a deductible loss?


Yes, yes and yes.

The Pub that Keiser cites in Post #36 has it right:

If you transfer a perpetual easement for consideration and do not keep any beneficial interest in the part of the property affected by the easement, the transaction will be treated as a sale of property.


As to this comment:

If so, why no deductible loss on the perpetual easement in my example?


Let’s back up. I think we need to clarify something here and also clarify some of the rules we’re trying to create. The something we need to clarify is the nature of the easement. Some key words here, including within the Pub reference above, are “beneficial interest” and whether or not we retain that.

What comes to mind here is our house that sits on a street. There is a land-locked lot behind our house that we also own. If we want to sell that lot so someone can build a house on it (or maybe we build a spec home) we’re gonna need to provide access to that back lot to whoever buys it. One way is to draw up an easement, so that the buyer of the lot can go from the main street, through the edge of our property to get to his. It seems to me that we could use that access even though there’s an easement on it. Now, if the state comes along and says they want an easement so they can build a highway through the side of our yard, well, we can’t really throw the ball with Junior there anymore. No more beneficial interest. In that case, I’m thinking we could take a loss. See Rev Rul 72-255.

Now, as to clarifying the rules, see if you agree:

1. If we grant a non-perpetual easement, it’s a lease.

2. If we grant a perpetual easement, and retain a beneficial interest in the portion so granted, no “sale.” We offset proceeds against basis. If proceeds exceeds basis, we have a gain. We might say we have a transaction that is tantamount to a sale, but for gain recognition purposes only. This is the S-corp distribution in excess of basis type of situation, wherein we retain an interest in our stock.

3. If we grant a perpetual easement, and do not retain a beneficial interest in the portion so granted, we have what is tantamount to a sale for both gain and loss recognition purposes. Note that a “beneficial interest” would not include bare naked title alone. The gist here is that if we grant an easement that causes our property to become worthless to us, we have a closed transaction for gain/loss realization purposes (and recognition purposes as well, assuming some deferral provision doesn’t apply).

There is a relatively new case, from 1928 (the earth is like 4 billion years old, you know), that said this:

Under the provisions of this instrument it is plain that about the only thing or interest remaining in the petitioner is the bare legal title and that this is of no practical or market value. According to the evidence and findings of fact, the petitioner has been deprived of all beneficial interest in the land, and it is useless for farming or grazing purposes. Under such circumstances, many courts hold that the granting of such an easement is tantamount to a sale of the fee. We have been cited to no case in Texas passing upon this question, but we find the general rule stated by the following authorities and text writers.

H. L. SCALES., 10 BTA 1024

Are we getting closer to understanding all this easement stuff? It’s not so “easy” now, is it…

Perhaps we need to re-read Post #36 in full and see if our set of rules aligns with the Pub.
 

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