How are eminent domain payouts taxed for Texas landowners?

When you receive compensation for an eminent domain taking in Texas, you might focus on the payment itself. You also need to understand how this payment affects your taxes. A little preparation helps you avoid surprises later.

How compensation for property affects your taxes

Compensation for land taken through eminent domain counts as a sale for tax purposes. You may owe capital gains tax if the payment exceeds your adjusted basis in the property. The adjusted basis usually includes what you paid for the property and certain improvement costs. You should also look at how long you owned the property because the IRS treats long-term and short-term gains differently.

How to handle compensation for lost improvements

If the government takes structures or improvements on your land, the payment for those items also counts as taxable gain. Improvements like barns, sheds, or fencing often have their own basis separate from the land. When you calculate your gain, you subtract the adjusted basis of each improvement from the part of the payment tied to that improvement. This helps you understand how much of the total compensation the IRS may treat as taxable.

How severance damages factor into your tax return

Sometimes the government only takes part of your property. In those cases, you may receive severance damages for the reduced value of the land that remains. These damages may reduce the basis of the remaining property before you report taxable gain. If the severance damages exceed the basis of the remaining land, the extra amount can create a taxable gain. You should separate severance damages from direct compensation in your records so you can report them correctly.

Ways to reduce your tax burden

You may qualify for a tax deferral under Section 1033 of the Internal Revenue Code. This rule allows you to postpone paying capital gains tax if you reinvest the compensation into similar property within a set time. The replacement property must serve the same use as the condemned property. If you follow the rules, you convert your taxable gain into deferred gain, which lowers your immediate tax bill.

A clear view of how eminent domain payments affect your taxes helps you plan your next steps. With the right information, you can make smart choices about reporting gains, reinvesting funds, and preparing for the tax year ahead.