Combining Sections 121 & 1031 for Optimal Tax Treatment

Real Estate Residence Tax Capital Gain Investment

Sections 121 & 1031

As we’ve noted before on HTW, Section 1031 of the IRC applies specifically and exclusively to real property used for business or investment purposes. Section 121, on the other hand, applies to primary residences, and can be utilized to eliminate substantial capital gain upon the sale of one’s property (up to $250,000 for single filers and $500,000 for married filing jointly). Though no taxpayer can use 1031 to exchange his primary residence, the tax code allows taxpayers to simultaneously utilize both of these sections in cases involving mixed use or dual use properties. In the 1031 industry, combining Section 121 and Section 1031 in this manner is commonly referred to as “split treatment.” In this article, we will discuss how this process of combining 121 and 1031 can be achieved.

Combining on the Sale

If a taxpayer has been living in a portion of the property he or she wishes to sell as part of a like-kind 1031 exchange, then the taxpayer may utilize 121 and 1031 on the sale. Suppose that the taxpayer owns a four-unit rental property and lives in one of the units; in this scenario, the taxpayer could sell the property, exclude up to 25 percent of the gain through the exclusion conferred by Section 121 and then defer recognition of up to 75 percent of the remaining gain by acquiring suitable replacement property as part of a 1031 exchange. Hence, in this example, the taxpayer would only be deferring whatever portion of the property is considered used for investment purposes.

Combining after a Conversion

Suppose a taxpayer acquires like-kind replacement property as part of an exchange but then wishes to convert the replacement property into a primary residence. Then, let’s further suppose that the taxpayer wished to sell the property outright after this conversion to a primary residence. In this scenario, the taxpayer would have benefitted initially from Section 1031 on the acquisition, but they would also be able to utilize Section 121 to exclude realized gain on the sale. Current regulations on converted property state that a taxpayer must own a property for a minimum of 5 years after completing a 1031 exchange in order to be eligible to use Section 121; what’s more, taxpayers must also live in the property as their primary residence for at least 2 years during that 5 year period.

Let’s illustrate this: suppose that a taxpayer exchanges into an investment property through a 1031 exchange and then moves into the property 2 years later. Suppose that the taxpayer lives in the property for 3 years and then decide to sell the property. The taxpayer could use Section 121 to potentially exclude up to $250,000 (if filing single), but he would only be able to exclude 3/5 of whatever gain is recognized on the sale. Even though the property would be classifiable as a “primary residence” at the time of sale, Section 121 could only offset a portion of the gain equal to the percentage of time spent living in the property.

Image credit: ccPixs.com

Top Areas for Future Home Buyers in the Greater Seattle Region

Seattle Real Estate Property Value Market

Seattle Real Estate Market

Though many of our clients are homeowners, quite a few of our clients are currently in the market (or plan to be in the market) for a new home. For this reason, in our present article we’d like to take a moment to highlight some of the hottest areas for real estate purchases in the greater Seattle metropolitan region. These areas offer plenty of perks to residents: pleasant scenery, easy access to downtown, safety, economic opportunities and many other benefits. If you are hoping to buy a house, condo or townhome in the near future, you should give serious consideration to a place in one of these areas.

And once you count yourself among the crowd of homeowners, be sure to keep coming back to HTC as we’ll be able to assist you with all of the tax-related issues homeownership can bring up.

Downtown Bothell

Though the economic recession of 2008-2009 slowed Bothell’s growth a bit, the city has managed to bounce back very well and has seen substantial development in the most recent few years. Multiple residential and commercial properties have been added to the city and more projects are on the horizon. The city boasts several important biotech and high-tech employers and also hosts the Bothell campus of the University of Washington. The median home value currently stands at $427,900 and the expected rate of appreciation is 5.2 percent.

Ravenna

Conveniently located very close to the University of Washington’s main campus and Seattle Children’s Hospital, the small town of Ravenna is an excellent choice for someone looking to acquire a stylish property in an urban setting. The town is receiving a large influx of tech professionals from California and elsewhere who are attracted to the stylish craftsmanship which characterizes Ravenna homes. Well-paid UW personnel and medical professionals are also flocking to the town given its location and pleasant community. The median home value is approximately $666,900 and the rate of appreciation is 7.1 percent.

Kirkland

Frequently regarded as Bellevue’s little cousin, the city of Kirkland is an easy choice for the most desirable real estate markets in the greater Seattle area. Between 2015 and 2016 the city saw a rise in home values of 11.7 percent and, though the exact rate will fluctuate, more good appreciation appears to be in store. Given its waterfront location and easy access to downtown Bellevue, Kirkland will likely continue to attract ambitious and affluent home seekers throughout the coming years. Kirkland Urban – the massive, mixed-use residential and commercial property which will host a movie theater, restaurants, bars, etc. – has an expected completion date of November, 2018 and play a considerable role in increasing Kirkland’s desirability.

Source

Image credit: Tim Durkan

Trump’s New Tax Proposal Could Have Substantial Impact on Seattle Homeowners

Trump Real Estate Deduction Seattle Tax Property Mortgage Interest

Trump’s Plan & the Seattle Market

President Donald Trump has developed a proposal to rewrite the tax code in such a way that it may render the mortgage interest deduction meaningless for all but a small minority of wealthy homeowners. Opponents argue that this provision would take away an important incentive of homeownership; supporters contend that the change benefits the majority of Americans and would expand homeownership opportunities for middle income earners.

Let’s examine Trump’s proposal in greater detail and highlight how the changes could impact the Seattle real estate market.

Proposed Revisions

The proposal contains a number of changes; perhaps the most important one is the raising of the standard deduction from its current level of $12,700 (for married couples filing jointly) to $24,000. On its face, Trump’s proposal does not eliminate the mortgage interest deduction, but its goal of substantially raising the standard deduction would mean that millions would cease to itemize their write-offs and consequently fail to deduct the interest from their home loan.

Trump’s plan also modifies existing deductions for state and local taxes, including property taxes. Opponents contend that the property tax deduction is another important perk of homeownership which should not be removed.

The Trump administration states that the changes will actually stimulate home purchases for low to middle income Americans because the higher standard deduction will enable greater savings. The proposal is also likely to trigger a measurable decline in average home pricings across the country which will increase access to homeownership.

Possible Impact

Currently, the Seattle real estate market has a median home price of approximately $722,250. This figure undoubtedly places Seattle among the most expensive real estate market in the country. Assuming the Seattle buyer puts down twenty percent, this median price means that the typical Seattle homeowner will pay roughly $2,735 per month in mortgage costs over a 30-year loan. Given its status, there’s no question that the Seattle real estate market will be impacted by the Trump proposal very heavily. A large number of our homeowners will suddenly be in a situation in which itemizing will no longer make financial sense. Trulia – the well-known property data provider – determined that the number of households eligible for the mortgage interest deduction in Seattle would drop from 56 percent down to 26 percent.

Whether Trump’s changes increase or decrease homeownership across the country obviously remains to be seen; what is certain is that the real estate industry as a whole is lined up in opposition to Trump’s proposal. Supporters and opponents both appear to have facts and figures which bolster their respective positions. Perhaps only a fair trial will determine whether Mr. Trump’s plan will be beneficial to the nation.

Source

Image credit: tiffany98101

To learn more about the mortgage interest deduction and other tax benefits of homeownership, see this presentation by our CPA Jessica Chisholm

Investment Property & the Personal Residence Exclusion

Vacation Home House Property Investment

Investment Property

Contrary to what many may suppose, the initial purpose underlying the acquisition of a property does not necessarily bar future invocation of the principal residence exclusion (under IRS section 121). As we’ve discussed earlier, Section 121 of the Internal Revenue Code allows homeowners to exclude up to $250,000 ($500,000 for married couples filing jointly) of gain from the sale of a “principal residence” (as defined by the code). What we haven’t mentioned yet, however, is that property may be converted from its original purpose — say, for investment — into a primary dwelling specifically to take advantage of the principal residence exclusion. This is an extremely useful piece of information for many real estate owners. In many cases, a person will acquire real property as an investment — a vacation rental house, for example — and then later decide to use that same property as a personal residence. As long as the property is used as a “principal residence” — meaning that the owner has used the property as a residence for at least two years out of the most recent five-year period — the owner may utilize the exclusion provided by section 121.

Converting Your Investment (Rental) Property into a Principal Residence

Perhaps the most common instance of “converting” a property initially used for investment purposes into a property eligible for the exclusion provided by section 121 is the conversion of rental property. If they have access to the requisite funds, many real estate owners choose to invest in rental property in order to generate regular supplemental income. They may decide to acquire a vacation house and then rent this property out to tenants. It may become financially beneficial (or financially necessary) for the real estate owner to eventually convert this investment rental property into a primary dwelling at some point in the future; once the owner satisfies the time requirements of the provisions of section 121, they can then sell the property and exclude as much of the gain as the section allows.

Converting investment property into a primary dwelling for the purpose of invoking section 121 of the IRC is just one piece of expertise that the team at HTC is familiar with. As promised, we will return to the sixteenth amendment very soon, but before we do we thought it helpful to draw attention to this little gem of tax knowledge. Stay tuned for more gems in the future!

Image credit: JD Lasica

If this article grabbed your attention, you should view our presentation on real estate tax advantages by our resident CPA Jessica Chisholm

The Basics of Tenancy-in-Common Ownership Arrangements

Real Estate Tenancy Common Ownership

Tenancy-in-Common Arrangements

Many of our clients are real estate owners and so in this installment of HTW we thought it beneficial to introduce the concept of tenancy-in-common ownership arrangements. A tenancy-in-common (TIC) is a form of joint ownership which involves multiple owners who share an undivided fractional interest in a single piece of real estate. This means that each owner possesses rights which are essentially identical to those of single owners rather than co-owners of typical partnerships. Being a co-owner in a tenancy-in-common arrangement confers numerous benefits; let’s discuss some of the basic characteristics of TICs and highlight a few of the distinguishing features of this type of arrangement.

Distinguishing Features

As mentioned, co-owners to a TIC possess undivided fractional interests in the underlying property. In practice, this means that they are not barred from freely transferring or alienating their interest in the TIC. At any time, a TIC co-owner can distribute their interest to another person without having to receive prior consent from the other co-owners. This distinguishes a TIC from other joint ownership arrangements, such as a tenancy-by-the-entirety.

Another distinguishing feature of TICs is the ability to have interests divided unequally among co-owners. Theoretically, in a TIC, one co-owner may possess a larger interest than other co-owners. In a scenario involving three co-owners, for instance, one co-owner may possess a fifty percent ownership and the two remaining co-owners may each possess an interest of twenty-five percent. This type of unequal division of ownership is either disallowed or typically not seen in alternative arrangements.

In a TIC, co-owners all share in the profits of the real estate and are all affected by changes in property value. Each co-owner receives a separate deed and insurance title to his or her interest in the real estate.

Another important feature of TICs is the ability of TIC co-owners to use their interest as part of a section 1031 exchange. As we’ve discussed several times, section 1031 allows capital gains tax to be deferred in the event that the proceeds from the sale of real property are reinvested in other real property of like-kind. Typically, section 1031 may not be invoked by traditional partnerships, but TICs are an important example of a jointly owned piece of real estate which may partake in a 1031 transaction.

In the near future, following a few more articles on the sixteenth amendment, we will discuss TICs in greater detail by exploring some legal cases involving TICs and section 1031 of the IRC.

Image credit: Phillip Pessar

Mercantile Trust Co. v. Commissioner & the Limited Importance of Contingencies

Real Estate Property Transaction Exchange

Real Property Exchange

Nearly every legal concept presently in use in these United States has an established pedigree. Very few of our concepts are recent inventions. This observation holds true not just in one or two areas of law but for quite literally our entire legal edifice. Section 1031 is no exception to this rule. Section 1031 is derived from a number of earlier tax acts which addressed the non-recognition of gains (or losses) when real property held for business or investment purposes is exchanged for like-kind property. Today, courts utilize the judicial opinions made in previous eras which were informed by one of these earlier tax acts. The case of Mercantile Trust Co. v. Commissioner (1935) is among the most significant of these opinions.

As we will see, Mercantile Trust Co. set an important precedent for viewing complex real property exchange transactions. Like the parties in Alderson v. Commissioner, the parties of Mercantile Trust Co. engaged in a complex transaction which involved multiple independent contracts, the use of an intermediary and a cash payment as “boot” on top of the exchange. In its opinion, the court emphasized that non-recognition depends primarily on what actually occurred, rather than on the various methods and motives which ultimately led to the transaction. Simply because a contingency could have given rise to a sale – and therefore would have created a taxable gain – does not necessarily bar non-recognition; the most important fact is whether an exchange of like-kind property actually transpired.

Facts

The representatives for Mercantile Trust Co. (the petitioners) appealed a judgment for a tax deficiency arising from a transaction involving Mercantile Trust Co., an intermediary (known as Title Guarantee & Trust Co.) and Emerson Hotel Co. The Commissioner of Internal Revenue (the respondents) claimed that the transaction amounted to a sale and that the petitioners had a recognized gain of $179,621 (approximately $2,521,070.02 when adjusted for inflation in 2016). The petitioners argued that the transaction had been an exchange of real property of like-kind within the scope of existing statutory provisions.

Title Guarantee & Trust Co., the intermediary, developed separate contracts with Mercantile and Emerson. To conclude certain of these contracts Title Guarantee made cash payments to the other party, and to conclude other contracts Title Guarantee accepted cash payments. Mercantile Trust Co. ultimately received the deed to the property (known as Lexington Street) originally held by Emerson Hotel Co. as well as a total of $24,426.90 in cash. Emerson Hotel Co. received the deed to the property originally held by Mercantile Trust Co. (known as Baltimore Street). Title Guarantee received commissions and title fees which added up to $8,573.10.

The respondents assessed the tax deficiency on the premise that Mercantile Trust Co. acquired the Lexington Street property in a separate transaction which should be considered a sale. The question before the court was whether the evidence on record supported this premise.

Law

The statutory provisions which applied to the case arose from section 112 of the Revenue Act of 1928. Section 112 (of the act of 1928) is the predecessor of section 1031 and includes many of the same provisions as the current law.

Ruling

The court (the U.S. Tax Court, known as the Board of Tax Appeals in 1935) ruled in favor of the petitioners and declared that the deficiency assessed by the Commissioner was without basis. The Commissioner argued that what had occurred was a “fictitious” exchange and that the Lexington Street property was acquired by Mercantile Trust Co. in an independent sales transaction. The tax court rejected this argument. The contract made between Mercantile Trust Co. and Title Guarantee included a contingency whereby Title Guarantee would pay $300,000 in cash in the event that the deed to the Lexington Street property could not be transferred. The court determined that this contingency did not negate non-recognition treatment given that an exchange of like-kind property did occur.

The reasoning employed by the tax court in Mercantile Trust Co. influenced later decisions, including the decision made in Alderson. The determination of non-recognition treatment depends heavily on the end result and not as much on the methods used to reach that result.

Image credit: Mike Fleming

Readers who enjoyed this piece about the famous case of Mercantile Trust Co. should check out our video on the tax perks of real estate ownership given by CPA Jessica Chisholm

Essential Points of the Principal Residence Exclusion

Real Estate Property Capital Gains Exclusion Residence

Excluded Capital Gains

In our first essay on section 1031 we promised to explore other sections of the tax code – namely, 1033 and 121 – which may be of interest to our readers. As always with HTC, we are true to our word. In this essay we will discuss some of the basic facts of section 121.

Section 121 is referred to as the “principal residence exclusion” because it allows gains derived from the sale of one’s primary residence to be excluded from taxable income (up to certain limits). Under 121, real property owners are permitted to exclude up to $250,000 in capital gains from the sale of their principal residence; married couples intending to file jointly may exclude up to $500,000.

In order to qualify for section 121 treatment, property owners must prove that they have owned and lived in the property for at least 24 months during the last 60 month period. It is not necessary that these 24 months be consecutive. Hence, under current law, it is theoretically possible to utilize section 121 once every 2 years.

Real property owners who wish to take advantage of section 121 have to keep a close eye on the market trends which affect the value of their property. As we know, property values tend to fluctuate throughout the course of ownership, and if the value rises too high then the property owner may end up having a significant tax liability even after section 121 is invoked. If a property’s value rises too high, converting the residence into a rental property and then utilizing section 1031 after a certain period of time has passed may be an optimal strategy.

In later installments we will cover section 121 in greater detail by examining legal cases and viewing examples of how section 121 has been utilized in real-world scenarios.

*It is worth mentioning that section 121 is the successor to section 1034. Section 1034 allowed taxpayers to defer 100 percent of the capital gain derived from the sale of their primary residence provided that they subsequently acquired another residence of equal or greater value. This section was replaced with the provisions of section 121 in 1997.

Image credit: Mike Rohrig

Tracing the Bounds of Section 1031 through Alderson v. Commissioner

Real Estate Property Exchange 1031 Tax

Real Estate

In our previous installment, we learned that whether a transaction falls under section 1031 of the Internal Revenue Code is an extremely important determination. Section 1031 enables taxpayers to receive non-recognition of capital gains when they exchange their real property for another property of like-kind. Real estate transactions can often result in gains of many thousands – and even millions – of dollars, and so receiving non-recognition of this sort under section 1031 can potentially remove very large tax liabilities. For this reason, the qualifications of section 1031 are narrowly construed by courts and so real property owners must carefully observe these qualifications to receive non-recognition treatment.

As with other areas of law, tax law is shaped by judicial opinions. Though the provisions of section 1031 originally emanate from the language of the tax code, the precise contours of these provisions are nonetheless informed and guided by the opinions issued in cases. This is the main reason Huddleston Tax Weekly has focused so heavily on highlighting tax, contract and property cases: it is important that our readers be aware not only of the various laws which may affect them, but also of how these laws apply in real-world scenarios.

The case of Alderson v. Commissioner (1963) gives us a sense of the level of conscientiousness required from the parties of a real estate exchange. As we will explore in detail below, Alderson shows that whether a cash payment is included as a contingency within an agreement is immaterial; the critical factor in determining 1031 treatment is whether an exchange of property of like-kind actually occurred. Alderson also demonstrates that property may be acquired specifically for the purpose of exchanging it as part of a 1031 transaction.

Facts

Alderson (the appellant) agreed to sell his property – referred to as Buena Park in the opinion – to a company known as Alloy Die Casting Company. Before the sale was concluded, Alderson decided he would prefer to exchange his property for another property which he discovered after the original agreement was made. This newly discovered property – Salinas – was then acquired by Alloy and transferred to Alderson in exchange for Buena Park.

The amended agreement between Alderson and Alloy included a contingency clause which stated that Alloy would pay cash for the Buena Park property in event that it could not furnish the Salinas property by a specific date.

Law

To receive section 1031 treatment, a transaction must involve the exchange of properties which are of like-kind. The transaction must also be reciprocal and involve a present transfer of ownership, the transfer cannot occur gradually or incrementally over a period of time.

Ruling

The court (U.S. Court of Appeals for the Ninth Circuit) overturned the opinion of the Tax Court and ruled in favor of Alderson. As noted above, the transaction between Alderson and Alloy was a bit convoluted and involved a formal amendment to the original agreement; two escrow accounts were created as a consequence of the decision made by Alderson to acquire the Salinas property. The Commissioner of Internal Revenue (the respondent) argued that the contingency clause provided evidence for the classification of the transaction as a sale rather than an exchange; the Commissioner also felt that the separate accounts provided evidence for this same conclusion. These arguments ultimately failed to persuade the court.

When determining whether a given transaction falls within the 1031 statute, the court considers the transaction as a whole and bases its decision on the true “substance” of the transaction. Though Alderson did initially agree to a cash sale, and the exchange was complicated by the opening of separate accounts, the substance of the transaction clearly reveals an intention to make an exchange of properties of like-kind. The court does not opine on hypothetical scenarios; the critical fact of Alderson was that the deeds for Buena Park and Salinas were exchanged, not that such an exchange may not have occurred if Salinas were not acquired.

Image credit: Shmector

Property owners should view this video by Jessica Chisholm to learn more about the tax perks of homeownership

Starker v. United States & the Qualifications of Internal Revenue Code Section 1031

Real Estate Property Capital Gains Section 1031

Real Estate Investment

Every real estate owner and investor should take the time to become acquainted with the elements of section 1031 of the Internal Revenue Code. This section allows taxpayers to defer recognition of either gain or loss when they exchange property of like-kind with another party. For any number of reasons, it may be wise for an owner or investor to exchange their property for another. Sans 1031, an exchange of real property would necessarily involve the realization of either gains or losses, and the management of such realization would require substantial investments of time and money. Section 1031 promotes a more open and free marketplace by eliminating the burdens which traditionally follow real estate sales.

Because of the heavy benefits it confers, section 1031 has rigid qualifications which are narrowly construed by courts. One case which illustrates the narrow reading of section 1031 qualifications is Starker v. United States (1977). As we will see, the plaintiff in this well-known case attempted to expand the construction of section 1031 so as to include a complex, multiyear financial transaction in which he took part. The court rejected the plaintiff’s attempt and set a precedent for a narrow construction of 1031.

Before hearing Starker, the court had just settled an earlier case, known was Starker I, which was heard in 1975 and involved the son and daughter-in-law of the plaintiff of the 1977 Starker case. The plaintiff’s son and daughter-in-law had also taken part in the same transaction which formed the basis for the suit of 1977; like the plaintiff, they tried to receive non-recognition of their capital gain under section 1031. The judge in Starker I concluded that the son and daughter-in-law correctly invoked section 1031 and were therefore entitled to a refund for taxes paid on the transaction. The next Starker case was heard by the same judge; this judge reconsidered his earlier decision and ruled against the plaintiff. As we’ve noted before, sometimes no amount of preparation can account for the whims of our magistrates.

Facts

The plaintiff transferred a very large amount of land – approximately 1,843 acres – to a company known as Crown Zellerbach Corporation. In return, the company created an “exchange value” balance on its books. To reduce the balance, the company was supposed to transfer a number of parcels of land to the plaintiff; as part of the agreement, these parcels did not need to be transferred all at the same time, but could be transferred one by one over the course of several years. Collectively, these parcels were supposed to be equal in value to the land given to the company by the plaintiff. The plaintiff also received a “growth factor,” which was interpreted as a type of interest by both the company and the court.

The plaintiff invoked section 1031 when filing the income tax return which included this transaction. The IRS denied this invocation and assessed a tax deficiency of $300,930.31 plus interest. The plaintiff then brought a suit to receive a refund.

The question before the court was whether the plaintiff was in fact entitled to non-recognition under section 1031 given the peculiar characteristics of his exchange.

Law

Under section 1031 of the Internal Revenue Code, taxpayers are entitled to non-recognition of capital gains or losses which arise from the exchange of property of like-kind. The exchange must be reciprocal and involve a present transfer of ownership; it cannot involve a promise to transfer property in the future.

Ruling

The court disallowed section 1031 and ruled in favor of the government. The court rested its decision on a number of factors. One factor was the element of time: the parties did not simultaneously exchange property of like-kind, but instead created a balance which was to be paid off incrementally over a period of time. And in the event that the parcels of land given to the plaintiff did not settle the balance after a period of five years, the agreement between the plaintiff and company held that the company would then transfer cash to cover the remainder. What’s more, two properties transferred by the company were not actually given directly to the plaintiff; the properties were given to the plaintiff’s daughter. And on another occasion, the plaintiff did not specifically receive the title to a property, but was given cash equal to the purchase price of the property along with the company’s right to acquire the property. These and other factors combined to provide a foundation on which the court made its decision to deny non-recognition treatment.

More than anything, our readers should use the Starker case to see the limited availability of section 1031. Where Starker applies, it can be an incredibly useful tool, but know that it only applies in scenarios which explicitly fall under its requirements.

In our upcoming installments, we will look at sections 1033 and 121 and highlight how these sections can also be of use to taxpayers.

Image credit: Pictures of Money

To learn more about the tax benefits of real estate ownership, please view our presentation by CPA Jessica Chisholm

Hawaii Housing Authority v. Midkiff & the Function of Eminent Domain

Law Market Economics Eminent Domain Property

Eminent Domain

One of the most enduring myths about government in the United States is the idea that governmental behavior is more or less congruent with standards of individual morality. In other words, most Americans believe that government authority is shaped and ruled by the same moral standards which shape and rule the behavior of the average individual. Governmental behavior may have special leeway in a few instances, but for the most part it is constrained by the same principles which constrain the typical man on the street.

This idea, while not without foundation, falls well short of capturing the truth. What most people do not realize is that governmental morality is based on processes which are altogether different from those which form the basis for the morality of the individual. Individual morality is based on reciprocity, the classic notion of “give and take”: we refrain from damaging our neighbor’s property or stealing goods from our friends because we expect this same kind of treatment in return. Individual morality is an exchange, it stems from the basic idea that whatever action or inaction we take will be reciprocated by whoever is affected.

And because our government is nothing other than a massive collection of individuals, many people assume that governmental behavior must be based on this same principle. In reality, however, this is not the case, because our government does not take part in the sort of interactions in which the individual takes part. Instead of reciprocity, government behavior is based on reason, it derives from a wholly rational process involving the weighing of pros and cons and the careful analysis of possible outcomes. A good deal of the confusion about government would quickly disappear if this fact were realized.

There are various ways to show that this is an accurate statement; today, we will use the concept of eminent domain to prove our case. Relatively few property owners are aware that the government has the constitutionally conferred power to confiscate private property, and that the exercise of this power is not limited strictly to times of war. Denuded of its lofty name, eminent domain is simply a forcible acquisition of the sort which would be punishable if committed by an individual citizen. Of course, this does not speak to its propriety, but only illustrates the fact that governmental behavior operates according to different rules. Let’s take a peek at the case of Hawaii Housing Authority v. Midkiff (1984) to get a sense of the contours of eminent domain.

Facts

On the island of Oahu, 22 landowners held 72.5 percent of the land titles. This oligopoly led to a distorted market which involved inflated prices and general social discontent. One landowner (the Bishop Estates) held an unusually large portion of land. The Hawaii Legislature passed a measure designed to redistribute the lots held by the Bishop Estates to their corresponding lessees. The legislature reasoned that this transfer of ownership was in the best interests of the entire community. The measure was brought before the Supreme Court of the United States in order to determine its constitutionality.

Law

The doctrine of eminent domain arises from the Fifth Amendment to the U.S. Constitution. According to the so-called “public use doctrine,” the government has the ability to transfer title of ownership if such a transfer serves a legitimate public good.

Ruling

In an 8-0 (unanimous) decision, the Supreme Court of the United States ruled that the measure adopted by the Hawaii Legislature was constitutionally valid. The court’s decision of this case was significant because the legislature did not transfer the title of the land to the “public,” but to a larger share of private homeowners. However, though this was the case, the court determined that the legislature’s invocation of eminent domain was valid because the correction of the market conferred a substantial benefit to the general public. In other words, in order for eminent domain to be invoked, private land does not have to be put specifically to public use; it only has to confer a clear benefit to the wider populace.

Of course, circumstances will rarely compel the typical homeowner to master the finer points of eminent domain; but it is still important for virtually every homeowner – and nearly every citizen, for that matter – to have at least a basic understanding of this concept. As citizens, we have to be aware of all the functions of our government, not just those which are the most visible or common. Eminent domain may not dominate the headlines of our most popular media, but as we’ve seen it is still remarkably important.

Image credit: Nicolas Raymond

In addition to a knowledge of eminent domain, our readers who own property will also benefit from the following presentation about the tax advantages available to homeowners

Huddleston Tax CPAs of Seattle & Bellevue
Certified Public Accountants Focused on Small Business

(800) 376-1785
40 Lake Bellevue Suite 100, Bellevue, WA 98005

Huddleston Tax CPAs & accountants provide tax preparation, tax planning, business coaching, Quickbooks consulting, bookkeeping, payroll and business valuation services for small business. We serve Seattle, Bellevue, Redmond, Tacoma, Everett, Kent, Kirkland, Bothell, Lynnwood, Mill Creek, Shoreline, Kenmore, Lake Forest Park, Mountlake Terrace, Renton, Tukwila, Federal Way, Burien, Seatac, Mercer Island, West Seattle, Auburn, Snohomish and Mukilteo. We have a few meeting locations. Call to meet John Huddleston, J.D., LL.M., CPA, Tawni Berg, CPA, Jennifer Zhou, CPA, Jessica Chisholm, CPA or Chuck McClure, CPA. Member WSCPA.