What if I Don’t Reinvest?!

Our reader from yesterday’s post followed up with this question:

“Follow- up on condemned highway tax problem. What happens when the proceeds are not reinvested in like find property?”

When you receive proceeds from a condemnation of your farm land, you have three years to reinvest the proceeds to defer the capital gains on the property.  However, if you end up not reinvesting enough of the proceeds, then you have a taxable event.  Also, you do not get to pro-rate the gain, but have to reinvest your original basis first and then any reinvested proceeds after that point reduces your gain.  Whatever gain ends up being realized is reported on the original tax return by filing an amended tax return and paying interest from the original due date until the payment is made.

For example, let’s assume our farmer receives $500,000 from the condemnation and his basis in the property is $150,000.  If he purchases property during the three year period that in total is less than $150,000, he has to report the full gain of $350,000 in 2011 by filing an amended tax return and paying tax and interest from April 15, 2012 forward.  If he ends up reinvesting $400,000, then he has to report a final gain of $100,000.  If he invests $500,000 or more during the three years, there is no gain, but his basis in the new property is reduced by the deferred $350,000 gain.