What Appraisal Evidence the IRS Requires for Severance

Appraisal Evidence — What the IRS Requires

By Steve Medendorp, Esq. · Tax Alpha Companies · August 2026

A severance damage allocation in the settlement agreement is necessary — but it is not sufficient on its own. The IRS requires that any allocation be supported by credible appraisal evidence demonstrating that the retained parcel actually lost the value attributed to severance damages. Without that evidentiary foundation, the IRS can challenge the allocation and recharacterize the entire award as proceeds from the property taken — regardless of what the settlement says.

The Standard the IRS Applies

The IRS does not prescribe a single methodology for valuing severance damages, but the approach that consistently survives scrutiny is the before-and-after appraisal: the appraiser establishes the fair market value of the entire property immediately before the taking, then establishes the fair market value of the retained remainder immediately after the taking. The difference — net of the value of the property physically taken — is the measure of severance damage.

This methodology is well-established in condemnation law and in IRS practice. An appraiser using accepted valuation methods, documenting their assumptions, and arriving at a before-and-after conclusion will generally produce work product that survives IRS review. The quality of the appraisal matters as much as the existence of one.

What Does Not Hold Up

Three approaches consistently fail IRS scrutiny and have been rejected by Tax Court:

1. Allocation Without Appraisal Support

A settlement agreement that allocates proceeds to severance damages without any independent appraisal to support the number is the most common and most vulnerable position. The IRS treats the absence of appraisal support as evidence that the allocation was not arm's-length or economically grounded. The entire award is then treated as consideration for the property taken.

2. Round-Number Allocations Without Documented Methodology

An allocation of, say, exactly $500,000 to severance damages — arrived at through negotiation rather than appraisal — raises immediate questions. The IRS will ask what the number is based on. If the answer is "we agreed to it," that is not sufficient. The allocation must trace to something measurable: a before-and-after value conclusion, a specific category of damage with quantifiable impact, or an expert assessment of diminished use.

3. Retroactive Appraisals

An appraisal commissioned after closing to justify an allocation already made is the weakest position of the three. Tax Court has viewed retroactive appraisals with skepticism, particularly when the appraiser was not involved in the negotiation and is working backward from a number already set. The IRS has successfully challenged these in multiple cases.

What to Document and Where

The supporting analysis — before-and-after appraisal, identification of severance damage components, documentation of the retained parcel's adjusted basis — belongs in the client's close-out file. It should be available and organized if the IRS ever requests it, but it does not need to be attached to the settlement agreement itself.

In fact, attaching a detailed appraisal to the settlement can create more problems than it solves, because it gives an auditor a precise roadmap to challenge individual line items. The settlement document should state the allocation in dollar terms. The supporting work product should sit behind it in the file, ready to produce if needed.

Documentation Checklist — For the Client Close-Out File

Confirm the close-out file contains: (1) a before-and-after appraisal by a qualified appraiser using USPAP-compliant methodology; (2) identification of severance damage components and the basis for valuing each; (3) documentation of the retained parcel's adjusted basis before the taking; and (4) the settlement agreement with explicit dollar allocations between property taken and severance damages.

This file supports the tax position if it is ever examined — it does not need to be part of the settlement itself.

Getting the Appraiser Involved Early

The single most important timing decision in severance damage planning is when the appraiser enters the process. An appraiser involved before settlement negotiations begin can build the allocation number from first principles — establishing the before-and-after value differential and helping negotiate an allocation that is both defensible and maximally favorable to the client.

An appraiser brought in after the fact is working to justify a number that has already been set, which is a much weaker position. If your client is still at the table, now is the right time. If the settlement has been signed without appraisal support, the options narrow considerably — but there may still be steps worth taking depending on the facts.

Key Timing Point

The appraisal should drive the allocation number — not the other way around. Get the appraiser involved before settlement negotiations conclude. Once the agreement is signed without appraisal support, the IRS position becomes significantly harder to defend.

Questions about severance damage documentation for a current client?

Steve Medendorp can help you think through the appraisal and documentation requirements before the settlement closes. No pitch, no obligation — a 30-minute conversation can make a significant difference in your client's tax outcome.

Schedule a Call with Steve → https://taxalphaeminentdomain.com/#book

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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