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Let's say you purchase 10 acres of land 30 years ago for $10,000 and that 10 years ago the city declared eminent domain on a portion of the land and built a road through it. Now you own two tracts of land on either side of the road - each tract smaller than the original tract and let's say someone offered to both of these two tracts for $1,000,000 each.

How would capital gains tax work at that point? The land that's being sold isn't the same land that was purchased - it's less. Would you pay capital gains on $990,000 x 2?

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I believe a key piece of the issue would be what, if any, compensation did the land owner receive for the portion of the property that now contains a road? That would be the first possibly taxable event. The subsequent sale would likely be the second taxable event. Check out the "Involuntary Conversions" section of this IRS publication: irs.gov/publications/p544/index.html – TS Haines Jan 29 at 17:57
    
Eminent domain just screws everything up now doesn't it. – Insane Jan 30 at 1:04
up vote 12 down vote accepted

When the city declared eminent domain, they should have compensated you for the portion of the land that they took. You should have had to pay capital gains on that when it was taken. Should have been something like (money received) -(fraction of land taken x $10,000).

Now you would pay capital gains based on your reduced basis. That would be something like (2 x $1,000,000) - [(1 - fraction of land taken) x $10,000].

I'm saying "something like" because in a real situation you may be able to include other costs in your cost basis to the extent they were costs necessary to the completion of the purchase. There's also the possibility that the land is not equally valuable, in which case you might need to make a correction to account for that.

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