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When a condemnation takes time to resolve — as most do — the condemning authority typically owes interest on the award from the date of taking to the date of payment. For the IRS, it is ordinary income, taxable in full in the year received, with no mechanism for deferral. This is one of the most consistently overlooked components of condemnation tax planning.
The Legal Basis for Condemnation Interest
In most states, just compensation under the Fifth Amendment includes not only the value of the property taken but also interest on that value from the date of taking — particularly when the government takes possession before final payment is made. In federal condemnations and many state proceedings, the condemning authority deposits an estimated amount with the court at the time of taking, and interest continues to accrue on any deficiency between the deposit and the final award.
The interest component can be substantial in protracted litigation — a case that takes three to five years to resolve can accumulate interest equal to 15–25% or more of the principal award.
The Tax Treatment — No Deferral Available
The IRS treats condemnation interest as ordinary income, not as part of the proceeds from the involuntary conversion of property. Interest paid as part of a condemnation award does not represent consideration for the property transferred — it represents compensation for the delay in payment. As such, it is taxable as interest income under section 61, not as gain from property under section 1033.
Section 1033's deferral mechanism applies only to "gain from an involuntary conversion of property." Interest income is not gain from a conversion. It cannot be deferred by reinvesting in replacement property. It cannot be excluded. It is recognized in full in the year of receipt at ordinary income rates.
Keep the Settlement Simple
On the question of how the award is documented, our position is consistent: less is best. How the interest component is characterized and tracked is a matter for the client's CPA and tax advisors to work through based on the specific facts. Unless the litigation or settlement terms specifically require a particular treatment, keep the formal documents clean and give the professionals the flexibility to reach the best supportable position on the back end.
Practitioner Note: The key for your client is knowing that interest income is in the picture and that it cannot be deferred. Once they understand that, their CPA can plan for the cash obligation before the award arrives — rather than discovering it at filing.
Next month: business loss claims in a condemnation — how clients recover for lost profits and what the IRS requires.
Planning Around the Interest Component
There is no mechanism to defer or exclude condemnation interest from gross income. The planning is entirely about cash management and accurate tax projections. The client needs to know that interest is part of the award before the check arrives so they can set aside the corresponding tax liability rather than reinvesting everything.
Interaction with the Section 1033 Election
The interest income does not affect the section 1033 election itself. The election applies to the gain on the property taken, determined without regard to interest. However, if the client mistakenly treats the interest as part of the reinvestable proceeds and deploys the full award into replacement property, the resulting tax bill may force a partial liquidation of the replacement property — potentially triggering additional gain and defeating part of the deferral the client was trying to achieve.
This communication is provided for educational and informational purposes only and does not constitute legal, tax, accounting, or investment advice. The strategies discussed are general in nature and may not apply to specific individual circumstances. Any examples are hypothetical illustrations and are not a guarantee of any particular result. Tax laws are complex and subject to change; readers should consult qualified tax and legal professionals before acting on any strategy discussed.
Matt Chancey, Ross Brannon, Johnny Borrelli and Jacob Harvey are Registered Representatives of Crescent Securities Group, Inc. ("CSG"), Member FINRA/SIPC and an Investment Advisory Representative of Crescent Advisor Group, Inc. ("CAG"), an SEC Registered Investment Advisor. Neither CSG or CAG are affiliated with Tax Alpha Companies, Including Tax Alpha Title and Tax Alpha Solutions. Brokerage services offered through CSG. Investment advisory services offered through CAG. Steve Medendorp is a Florida licensed attorney but does not provide any legal or tax advice. Steve Medendorp and CSG or CAG are not affiliated.
This is not an offer to sell or a solicitation of an offer to buy any security that can only be sold by prospectus or confidential private placement memorandum. Strategies discussed are speculative, illiquid, and involve significant risk, such as potential loss of principal. All investments contain risk and cannot be guaranteed and you can lose some or all of your investment. Past performance is not indicative of future results. Prior to making any investment/financial decision you should consult your financial advisor and your accountant.