When you hear someone talk about building new pipelines or wind turbines, they often refer to securing an easement or a right-of-way. Farmers and ranchers are increasingly receiving easement, or right-of-way payments for expanded roadways, pipelines, wind turbines, electrical towers and similar permanent improvements that have a permanent impact on the use of their property. Temporary easements are generally treated as rental income, whereas perpetual easements involve a permanent impact on the land and thus are treated as an outright sale.
Background on perpetual easements
Easements and right-of-way payments, even if they are labeled as a lease, do receive sales treatment. Keep in mind:
- Easements are treated as a recovery of the basis of the property first, with any excess proceeds treated as capital gain, which is taxed at a lower rate than ordinary income.
- The basis of property that offsets an easement is limited to the basis of the affected acres or square footage.
- If damages are paid for the impact on growing crops or repair and maintenance of the soil, the proceeds are reported as ordinary income on Schedule F.
For example, John, an active farmer, grants a permanent easement to an investment group to construct two wind turbines on his farmland. The terms of the arrangement specify a $10,000 payment for damage and disruption to crops during the construction period and a one-time “lease payment” of $30,000 for the four acres that are affected by the wind turbines.
John reports the $10,000 easement payment for the damage to crops as ordinary income on his Schedule F. The $30,000 payment for the impact of the wind turbines on the four acres of the property is treated as a sale of the property. John uses the $30,000 amount to reduce his basis in the land for the four acres that have been affected. If the basis is less than $30,000, the excess is reported as a Section 1231 capital gain from the sale of land held for more than one year.
Long-term vs. perpetual easements
Easements with a term of 30 or 40 years are generally classified as long-term. Examples of long-term easements granted sale treatment include:
- Air rights were granted to the government.
- Easement of indefinite duration to a livestock producer.
- Easement to an electric power company for a pipeline with no mention of the duration of the easement to the farmer.
- Perpetual conservation easement.
- Pipeline company easement whereby under the contract, the easement and right-of-way grants amounted to the perpetual easement in land.
Examples of fixed-term easements which are reported as ordinary income or rent treatment include:
- Coal mining surface rights are granted under a 35-year easement.
- Conveyance of easement is limited to the period required to remove minerals.
- Easement right to use a road for a ten-year contractual period.
Treatment of long-term easements
There are situations where long-term leasehold (easement) interests are treated as the equivalent of a real property interest:
- Like-kind exchange regulations allow a leasehold interest of 30 or more years, to be eligible for exchange treatment.
- In the information reporting requirements, regulations provide that a leasehold, easement or timeshare of a term of at least 30 years is subject to reporting as the gross proceeds from real estate transactions on Schedule 1099-S.
If you have additional questions on how to handle easements and right-of-way payments for tax planning purposes, BerganKDV can help. Contact us today and one of our professionals would be happy to assist you.
Hi, We paid an individual for water utility easement for a temporary amount of time. There are no proceeds involving a sale or exchange of a property. What 1099 form is the correct form if you have noted 1099-S is 30 year span?
If the easement is not considered to be a perpetual or long-term easement, then the amount should be reported on 1099-MISC form.
We received an easement and the amount is larger than our cost base of the land. Do to our circumstances this year with our expenses, we would like to claim for full easement amount as income as capital gains. Even with claiming it all as capital gains we would not have to pay any capital gains tax on it this year for sure do to our expenses. We will eventually end up selling the land, since we have nobody to inherit it. So we would like to keep our cost basis of the land to use when we sell it… Read more »
Hi Lynette, we would need more information on the type of easement you received to provide an answer. Please reach out to us at info@BerganKDV Team.com and we can help!
In the example above, if the basis for the land is greater than the lease payment received, (thus reducing the basis in the land) is the lease payment reported anywhere on the tax return?
The lease payment would need to be reported on the tax return. But if the land basis is greater than the proceeds received, report the basis in land equal to the proceeds received so that there is not a gain or loss on the transaction.
Mitchell Estling, CPA