Eminent Domain

17 Replies

I am a seasoned investor (15 years and over 60 SFH) in Northern Illinois. I have a property next to one of the local High Schools that is being taken for some school expansion projects. They have given me a good price (after 3 months of negotiating) and my question is this. I know I can do a like kind exchange (1031) to defer the capital gains but is there another way since it is via eminent domain? I have historically bought foreclosed property and forced appreciation. With the time limits of a 1031 I may have to overpay for a property and that is killing me just thinking about it.

As a side note, negotiating with a School District was a very interesting process. At the end of the day, their final offer was actually more than my previous figure (about $6k). They said they had deadlines to meet and they would give me the extra if I could close in 45 days. That day I gave my tenants a 30-day notice to move. Paid $51k about 7 years ago (about 6 mo before the bubble burst) and their final offer was $105k. I love real estate.

Thanx for all your help

@Steven Hamilton II

may know of any issues with forced sales by ED.

I know that part of what you're getting is not allocated to the property but to relocation allowances, or can be, it should be broken down as to what is being paid for what.

I've done ED from the government side, it is usually fair if not more than fair. Most just get tied up emotionally.

Need to find a title company that acts as an intermediary in 1031s they can fill you in, I'd start looking for a replacement property, there should be a good inventory in your area so don't worry, it won't help. :)

Hi Tim,

You may qualify for a 1033 Exchange (Section 1033 of the Internal Revenue Code). The 1033 Exchange is for involuntary conversions such as eminent domain or natural disasters. You will qualify IF your property was actually taken via eminent domain or you were threatened with eminent domain.

It was not clear in your OP as to whether the city actually took your property via eminent domain or merely negotiated with you to buy your property. If the city did not actually take your property, you would have to demonstrate that you were threatened with eminent domain should you fail to sell your property to the city. The best ways to do this would be to have the city include language in the Purchase and Sale Agreement that they intend to take your property via eminent domain should you fail to close or they can put the same language in a letter to you. You need to show that you were threatened with eminent domain.

The other issue to keep in mind is that the definition of like-kind property pursuant to a 1033 Exchange is slightly more restrictive than a 1031 Exchange. If you stay with SFR's, you should be fine.

Very good point Bill! I assumed it is ED.

Getting that statement in a contract may be difficult in some places. The mention of ED requires the empowered entity to take actions and justify the action. Any implication or threat of ED to a land owner is regulated at the state level and often federally if that entity is tied to federal funds toward any project. Officials can't just walk around being a bully with the power of a pen and making offers you can't refuse. Often, I bought properties without saying ED, simply that other alternatives may exist, which was close enough of a threat, but I'd never put it in a contract and simply try to make it as a clean purchase. If asked if I'd use ED, I'd usually say no, not at this time that is not our intent. The owner must feel free to negotiate.

So, Bill's point should be a concern if you really need those distressed options.

You may be more likely to get a letter that clearly implies the School's options if they have not gone through the state requirements to follow through with any ED matter. If they did mention ED specifically in any letter initially to you, you've probably got it made. :)

It has to be a clear threat of eminent domain if you want to be safe under an audit. I have been involved as an expert witness in two IRS audits where the service took the position that there was no threat and disqualified the 1033 Exchange. The cities took the same approach where they mentioned "other options" and the service said it was not clear what they were talking about.

Bill and Billy, Thank you for your responses. I have done a couple 1031 exchanges in the past and I have a qualified intermediary already.

As for the 1033 exchange, I had not heard of that option and will look into it. What are the basics that differ from a 1031 exchange? Timing differences from a 1031?

The School District and I have worked out a deal and have a signed contract. My intermediary gave me an addendum to include regarding this being part of a 1031 exchange. While we did not go thru an ED process, the people I was dealing with used the term a few times and I understood it to be that if we did not come to terms they would use their ED powers. Not positive, but I believe I could have them write a short letter stating that this was resolved equitably prior to the use of ED.

I was first contacted by the school district about 4 months ago. Because of the small size of this case, a reverse 1031 was cost prohibitive so I was not able to get a replacement property under contract until I had the signed contract from the school district. As I said, I normally buy REO or other distressed property and force appreciation. With the markets improving (slow but steady in my area), there are fewer and fewer bargains to be had by the local investor community. When you are used to paying wholesale for something, paying retail or even discounted retail just feels wrong.

Thank you again for your reply

If your QI doesn't know about a 1033 or hasn't presented it to you I would have reservations.

The QI's I use know every facet about exchanging. The QI you have now is working your deal so it's hard to be an outsider on a forum looking in as there might be other things not said.

Verbal means nothing with an audit. Those same people telling you that in the moment will deny everything later on. It only counts if it's on paper and signed and dated by the people that matter with the correct language needed.

No legal advice.

Since I'm the oldest I suppose I'm Bill :)

I don't see any reason that you can't take the standard provisions of a 1031 your you rental property, Bill E is the 1031 expert here and he may be speaking to the requirement for the ED under some other benefits allowed in such cases. Doesn't matter who your buyer is.

With any special provisions under the Code, the IRS isn't completely full of dumbies they probably know the restrictions or requirements of ED and use that approach to limit or justify such benefits under distressed circumstances. It may be part of the caution taken by officials in mentioning ED matters due to tax ramifications for the victim...things in government are often tied together and often without awareness of those in government in dealing in some manner. When I was dealing in areas of ED, I have to admit, the thought of a seller using a 1031 never crossed my mind, that wasn't my interest.

I'd then suggest you begin using your methods employed in finding those distressed sales for your purchase.

As I mentioned above, your contract is important in avoiding having the full proceeds being applied directly to the gain on the property. While it may make little difference in your taxable income, it could. Flip side is disallowing any expenses in the property will reduce the amount applicable to the property for an exchange going into another property. Might be worth speaking to a CPA or experienced accountant......30 minutes with an attorney who has experience in ED isn't a wild notion either. :)

Joel,

I guess since the first couple times I used this QI, it would only qualify for a 1031 exchange he must have just gone with that. That and the fact when I called him I specifically asked about a 1031. I will contact today about the 1033. I already sent an email to my contact with the school district about getting a letter that says we settled this before it went to eminent domain but that was an option they were prepared to use. We will see if they respond.

Thanx for the rely. I always learn from this group.

You do not use a Qualified Intermediary in 1033 Exchange transactions. You are permitted to receive the funds personally. You would only use a Qualified Intermediary for 1031 Exchanges. Your Qualified Intermediary should know that, or chose to not mention it in order to get the business, in either event I would be looking for another Qualified Intermediary that is more knowledgeable and/or puts your interests first and not theirs.

You must be able to prove that your property was taken by eminent domain, or that you were actually threatened by eminent domain, if you get audited. The fact that it was discussed is not a threat. I would have them put it in writing on their letterhead and specifically state that if you fail to sell the property to them they intend to take the property via eminent domain. This will eliminate any risk during an audit.

I would then terminate the 1031 Exchange with the Qualified Intermediary and structure the 1033 Exchange. If the agency is not willing to put it in writing so that you are unable to prove intent to take the property under eminent domain, I would proceed with the 1031 Exchange and deal with the time lines.

The 1033 Exchange allows you three years to reinvest in replacement property when your property is taken under eminent domain. As stated above, you do not use a Qualified Intermediary. You merely have to trade equal or up in value. You do not have to reinvest your net proceeds (cash) either like you do with a 1031 Exchange. You can pull some or all of your cash out and not recognize any cash boot.

Bill, Thank you for the input. I got a call from the School District rep asking for the mailing address I wanted the letter sent to. He had forwarded my email on to their attorney asking that they put in writing the fact they were going to use ED if we did not come to a deal. Sounds like it is going in the right direction for me.

As for the replacement property under a 1033 exchange, can it be multiple properties? I sell 1 SFH and buy 2 or 3 SFH over multiple transactions, (purchase 1 at a time until I spend all the proceeds)? The last 1031 I did was a 3 family into 2 SFH but that was about 7 yrs ago. As for the proceeds, do I need to segregate them from my normal operating funds or can they be co-mingled until I spend the money on replacement property?

Your info and insight is very appreciated. Thank you.

Tim

Hi Tim,

You can acquire multiple properties as long as the total (aggregate) amount of what you buy is equal to or greater than the property taken via threat of eminent domain.

The cash (equity) does not need to be segregated. You can comingle the funds with the rest of your personal funds. The only requirement is that you trade equal or up in value. It does not matter how you pay for it. You can keep some or all of your cash and not have to worry about cash boot like you would in a 1031 Exchange.

Thank you Bill, I feel a sense of calm coming over me now that I know I do not HAVE to buy something in the next few months and possibly overpay.

Tim

Interesting. DOT is taking 50 ft beyond existing right of way from one of our properties. Of course, they are taking 50 ft from every property owner on the street to 5 lane it. fortunatley the home sits a good 300 ft back on a lot that is 100 wide x 600 deep. There is no mention about what we all get paid for ID 50 ft. Numerous times in different meetings it has-been said it is not worth fighting because ID pay out is fair or more than fair...