Severance Damages — Maximizing the Allocation
By Steve Medendorp, Esq. · Tax Alpha Companies · August 2026
In a partial taking, the condemning authority is paying for two things: the property actually taken, and the damage done to what remains. The second payment — severance damages — is where significant tax planning lives. It is also where the most money is routinely left on the table, because the window for planning closes the moment the settlement is signed.
Severance damages compensate the property owner for the diminished value of the retained remainder after the taking. Under IRS rules, severance damages first reduce the adjusted basis of the retained parcel rather than triggering taxable gain. If the severance damages received do not exceed the retained parcel's basis, the client recognizes no income at all on that portion of the award.
For a client with meaningful basis in the retained parcel, this is not a minor planning point — it can be the difference between a significant tax bill and none at all on hundreds of thousands of dollars in proceeds. The math is straightforward: money characterized as severance damages absorbs against basis first; money characterized as compensation for the property taken flows through the gain calculation immediately.
The condemning authority is typically indifferent to this characterization. Their total payment is the same regardless of how the award is broken down between the taken parcel and the retained remainder. That indifference creates an opportunity — one that expires at closing.
The IRS position is unambiguous: the allocation between compensation for property taken and severance damages must be established in writing before the transaction closes. A retroactive allocation — one negotiated or documented after the settlement is executed — will not be recognized. The IRS will treat the entire undifferentiated payment as proceeds from the property taken, which means the full gain calculation applies.
This is not a technicality. Tax Court has consistently sustained IRS challenges to post-closing allocations, even when the economic argument for a severance characterization was otherwise sound. The documentation must exist in the settlement agreement, not in a subsequent letter or memorandum.
The condemning authority will often resist a large severance damage characterization, in part because it implies their project caused more harm to the remainder than they want to acknowledge publicly. The practical approach is to document the damage to the retained parcel in concrete terms before entering final settlement negotiations: loss of access, severance of utilities, reduced highest-and-best-use, physical isolation of remaining parcels, or elimination of prior uses that depended on the taken portion.
That documentation — ideally supported by an independent assessment of the retained parcel's before-and-after value — gives the negotiation a factual foundation rather than a number pulled from the air. Condemning authorities are more likely to accept a severance damage characterization when it is grounded in something they cannot easily dispute.
Our practice is to keep the settlement document itself simple. A clear dollar allocation between property taken and severance damages is necessary — but we generally advise against loading the settlement with detailed breakdowns, attached appraisals, or itemized component lists. Less detail in the formal document preserves flexibility for your client's tax team. More detail gives the IRS a roadmap. The analysis and supporting documentation belong in the client's close-out file, available if needed, but not embedded in the agreement itself.
Practitioner Note
The settlement agreement should identify the allocation between property taken and severance damages in explicit dollar amounts. The IRS requires the allocation to appear in writing before closing; a subsequent letter or memorandum after execution will not substitute. If your client is still at the negotiating table, this is the conversation to have today — once the settlement is signed, the window is closed.
Severance damage planning is one of the most accessible tax strategies available in a partial taking, and it costs nothing to negotiate. The only requirement is that it happen before closing. Attorneys who raise this question early — ideally before settlement negotiations begin in earnest — consistently produce better tax outcomes for their clients than those who surface it after the fact.
If you have a client currently in a partial taking situation, this is worth a conversation before the deal is done.
Have a client in a partial taking right now?
Steve Medendorp works directly with eminent domain attorneys to analyze severance damage allocation before the settlement closes. No pitch, no obligation — put something on the calendar and let's talk through the situation.
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THIS IS NOT LEGAL ADVICE
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, Jimmy Nelson 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.
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