If you receive payment for an easement or right-of-way on your land, you may or may not have income subject to federal income tax. You may receive payment for an easement or right-of-way to allow pipelines, electrical cables, or telephone lines to be installed, or for a portion of your land to be flooded, for example.
Whether the payment is taxable depends on your basis in the land or other property subject to the easement or right-of-way. According to the IRS, if the payment you receive for the easement or right-of-way is less than your basis in the property affected, you would reduce your basis in that portion of your property. Then if you eventually sell or dispose of the property, the fact that your basis is reduced would increase your gain on the sale or disposition or reduce your loss, with the corresponding income tax consequences.
Your basis would generally be your cost, unless you acquired the property by gift or inheritance. You can find information on how to determine the basis of your property in IRS Publication 551, Basis of Assets. You could allocate your basis in the property by acres or square feet, depending on the easement or right-of-way contract or agreement.
If the payment you receive for the easement or right-of-way is more than your basis in the property, you would first reduce your basis to zero. The excess would be treated as gain from the sale of the property for tax purposes. This gain would be reported on Form 4797, Sales of Business Property, if you use the land for farming or some other business purpose. If you held the land for more than one year, you can treat the gain as a Section 1231 gain.
According to the IRS, if you have a farm and your crops are damaged as a result of the construction for the easement or right-of-way, any settlement payment you receive for the crop damage would not reduce the basis in your property. Instead it would be reported as other income on Schedule F.
If the property affected by the easement or right-of-way is not used for farming or another type of business, you would also reduce your basis in the property. The IRS points out that if it is not possible or practical to separate the basis for the part of the property affected by an easement, you can reduce your basis in the whole property.
If the payment you receive is more than your basis, you would report the easement or right-of way as a sale of the property.
If you are forced to grant an easement or right-of-way under threat of condemnation, you would report the transaction for tax purposes as a gain or loss on condemnation.
The IRS points out that if you grant a perpetual easement as a qualified conservation contribution, you could treat it as a charitable contribution and not as a sale, even if you keep an interest in the property.
Sources:
Form 4797, Sales of Business Property
Publication 225, Farmer’s Tax Guide, IRS
Publication 544, Sales and Other Dispositions of Assets, IRS
