Rev. Rul. 60-69

Advice has been requested whether, under the circumstances described below, the taking of certain easements, privileges, and rights of a taxpayer constitutes an involuntary conversion within the meaning of section 1033(a) of the Internal Revenue Code of 1954; also whether, under these circumstances, the expenditures of the proceeds received as damages will constitute the acquisition of property similar or related in service or use to the property involuntarily converted for purposes of section 1033 of the Code and, if so, whether the prescribed replacement period may be extended if the taxpayer is unable to replace the converted property within such period.

Under condemnation proceedings in 1958, a public utility corporation took certain easements, privileges, and rights of a taxpayer with respect to his business property for the purpose of erecting a dam across a river below the taxpayer's property. The dam, when completed, would raise the water level to such an extent that it would flood the basement of the taxpayer's manufacturing plant as well as the taxpayer's land adjacent to the plant and would make the plant inoperable unless protective measures are taken.

A committee was appointed by the court in order to determine the amount of anticipated damages and, based upon the committee's findings, an award was made to the taxpayer. The taxpayer is using the proceeds of the award to take protective measures to safeguard the plant from flood conditions. Based upon engineering studies, it was estimated that to complete the protective measures to safeguard the plant would require more than one year after the close of the first taxable year.

Section 1033(a) of the Code defines an involuntary converion as a transaction in which property has been compulsorily or involuntarily converted, as a result of its destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof. The power of requisition or condemnation implies the taking by public authority for its own purposes.

Section 1033(a) further provides for nonrecognition of gain from such conversions which occur after December 31, 1950, to the extent and in the manner provided in that section, where the amount realized is used to purchase property similar or related in service or use to the property so converted within one year after the close of the first taxable year in which any part of such gain is realized.

Section 1.1033(a)-2(c)(3) of the Income Tax Regulations provides that the replacement period may be extended to such later date designated pursuant to the taxpayer's application to the District Director of Internal Revenue for the district in which the taxpayer files his return. However, no extension of time will be granted pursuant to such application unless the taxpayer can show reasonable cause for not being able to replace the converted property within the required period of time.

In Revenue Ruling 271, C.B. 1953-2, 36, where a state highway commission condemned a strip of land through a taxpayer's farm for highway purposes, the Commission paid him an amount for damages sustained to the remaining farm property in addition to the condemnation award. The taxpayer expended this additional amount to restore the farm to the same operating condition as it was prior to condemnation. It is held in Revenue Ruling 271 that the additional amount the taxpayer received constituted compensation for conversion of his rights to use his farm in the usual manner and that the expenditure of that amount to restore the usability of the farm constituted acquisition of property similar or related in use to the property converted within the meaning of section 112(f) of the Internal Revenue Code of 1939. That section corresponds to section 1033 of the 1954 Code.

In the instant case, the court recognized the taking of certain easements, privileges, and rights belonging to the taxpayer, which taking would render the taxpayer's plant inoperable for the purpose acquired. Both the taking authority and the taxpayer produced evidence in court to show that the plant could be maintained by taking certain corrective measures. Both parties offered evidence of real estate experts of the market value of the property before and after the taking, which evidence was given due weight by the court in awarding damages. It was estimated that the actual expenditures to preserve the operating condition of the plant would exceed the proceeds received.

From the above, it is clear that the taxpayer is entitled to the relief provided by section 1033 of the Code in taking such protective measures as are necessary for the property to be used as it was before the taking.

Ordinarily, requests for extensions of the period of time to make replacements or restoration of property are neither made nor granted until near the end of the replacement period, as provided by the statute, or as previously extended, and then such extensions are usually limited to a period not exceeding one year. The granting of extensions depends upon the facts and circumstances in each particular case. The high market value or scarcity of replacement property has not been considered sufficient grounds for granting an extension. See W. J. Fullilove et ux. v. United States , 71 Fed.(2d) 852, certiorari denied, 293 U.S. 586. Where, however, as in the instant case, evidence submitted clearly shows that the replacement or restoration cannot be made within the statutory period, a request for a reasonable extension of such period will be granted.

Based on the foregoing facts and circumstances, it is held that the taking of the taxpayer's easements, privileges, and rights constitutes an involuntary conversion within the meaning of section 1033(a) of the Code. The expenditure by the taxpayer of the proceeds received as damages to enable the plant to continue in operation at its former capacity constitutes the acquisition of property similar or related in use to the property involuntarily converted. Thus, if all of the conditions of section 1033 of the Code are met, no gain will be recognized if the full amount of the proceeds are expended for such purpose. To the extent the proceeds are not so expended, they should be applied in the reduction of the basis of the retained property. To the extent the unexpended portion of the proceeds exceeds the basis of the retained property, gain will be recognized, subject to the limitations provided in section 1231 of the Code.

Furthermore, if the taxpayer can show reasonable cause for not being able to complete the replacement of the converted property within one year after the close of the first taxable year in which any part of the gain upon conversion is realized, or within any extension of that period, further reasonable extensions may be granted.