Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 73-35

1973-1 C.B. 367

Sec. 1033

IRS Headnote

Nonrecognition of gain applies to severance damages from a condemnation that destroyed the retained property's usefulness, where the retained property was sold and replacement property acquired at a cost exceeding the condemnation award, severance damages, and sale proceeds.

Full Text

Rev. Rul. 73-35

Advice has been requested whether the nonrecognition provisions of section 1033 of the Internal Revenue Code of 1954 apply to severance damages received by a taxpayer under the circumstances described below.

The taxpayer owned and occupied a manufacturing complex that included a number of contiguous buildings. In this complex, it manufactured goods along a continuous flow of conveyors. During the taxable year, a substantial portion of the taxpayer's property was condemned by the State for purposes of the construction of a proposed interstate highway. The taxpayer declined the state's offer for the property condemned and litigated the issue on the premise that the partial taking of the building complex completely destroyed the economic unit and effectively destroyed the use of all its related plants in the area. The jury awarded the taxpayer a larger sum than that offered by the State. The award included an amount for the property actually taken (condemnation award) and an amount as severance damages for damage to the remaining property. The nature of the taxpayer's business made it impossible to restore the integrated manufacturing complex as an economically profitable unit on the retained property. Furthermore, suitable nearby property that could be utilized with the retained property to accomplish such restoration was not available. The retained property was therefore sold. The taxpayer then, within the prescribed period of time set forth in section 1033(a)(3)(B) of the Code, invested an amount in excess of the full amount of the award and the proceeds from the sale of the retained property in acquiring property some distance from the taxpayer's former location. This new property is similar or related in service and use to the old property.

Section 1033(a) of the Code provides for the nonrecognition of gain when property is involuntarily converted as a result of condemnation and the taxpayer, within the prescribed period of time, purchases other property similar or related in service or use for purposes of replacing the condemned property.

Severance damages are compensation in addition to the award paid for the property actually condemned when the value of the retained property has decreased as a result of the condemnation. In this connection, Revenue Ruling 68-37, 1968-1 C.B. 359, states that severance damages are analogous to the proceeds of property insurance since they represent damage to property. The nonrecognition of gain provisions of section 1033 of the Code apply when the severance damages are used to restore the retained property to its former condition. See Revenue Ruling 271, 1953-2 C.B. 36. In Revenue Ruling 69-240, 1969-1 C.B. 199, the Service held that the expenditure of severance damages to acquire adjacent farmland to permit the continuation of a farming operation as before the condemnation constituted an acquisition of property similar or related in service or use under section 1033 of the Code.

Revenue Ruling 59-361, 1959-2 C.B. 183, provides that if property sold had a substantial economic relationship to the taxpayer's condemned property so that the entire property constituted one economic property unit, and if suitable nearby replacement property for the condemned property was unavailable, the taxpayer is entitled to the relief provided by section 1033 of the Code with respect to the proceeds of the sale even though the property sold was not itself subjected to condemnation.

Here, the retained property had a substantial economic relationship to the condemned property and after the condemnation became unprofitable for use in the taxpayer's manufacturing business. Since suitable nearby property was not available to replace the condemned portion, the sale of the retained portion was, under the rationale of Revenue Ruling 59-361, an involuntary conversion for purposes of section 1033(a) of the Code. Since the severance damages were with respect to the retained property, the sale of which constituted an involuntary conversion under section 1033(a) of the Code, such severance damages should be given the same treatment as the sales proceeds.

Accordingly, based on the above, the taxpayer may, under section 1033(a) of the Code, elect to defer the recognition of gain from the disposition of its old property, since the amount it invested in acquiring property that is similar or related in service or use to the old property exceeded the total of the condemnation award, the severance damages, and the proceeds from the sale of the retained portion of the old property.