When you give another person or business – for example, a utility company – access to or through your property, you grant that person an easement. When you grant an easement, you receive easement payment or consideration for that easement. Whether you provide a right of way easement or sell a portion of your property outright determines whether or not you pay taxes on payments you receive.
If you grant a neighbor or company access to your property for a specific period of time, any easement payments you receive are not taxed as income. However, if you sell a portion of your land, then you can expect tax implications.
Use of Land
You may grant your neighbor or a utility company access to or through your land to get to their real property. This type of easement is referred to as a right of way. Someone now has the right of way over your property – often for a specified period of time – but you still own the property. You may also provide someone with permanent access to a section of your property via a sale. In this scenario, you divide out the portion of the land the utility wants and sell that portion. These different methods have different tax effects.
Right of Way Easement Taxability
Your neighbor may request an easement to use the back driveway on your property to access their second garage. They offer to pay you $50,000 for a 30 year easement. Under this scenario, you have no taxable income or gain to report. Instead, the easement reduces your basis in your property. Via the easement, you essentially sold an interest in your property, but not the property itself. If your property basis was $375,000, your grant of the ROW easement drops your property basis to $325,000. When you eventually sell your home, you must use the $325,000 figure to compute the sale of easement capital gain on the home.
Sale of Portion Example
Your neighbor wants to build a second garage. However, in this scenario, a rectangular section of your property that abuts your neighbor would be perfect for him to install a new driveway. He asks you to sell him that section for $100,000, and you agree. You must book this sale of a portion of your property as a capital gain.
Taxes on Portion Sold
If the portion of the land you sold represents 15 percent of the total acreage of your property, then your basis in that portion equals $56,250, which is 0.15 times $375,000, the price you originally paid for your home. Therefore, the $100,000 payment provides you with a $43,750 gain on the sale of your property. You must report this gain on your tax return as taxable income, capital gains. Because you do not live in the portion of the property you sold to your neighbor, you cannot use the personal residence exclusion to abate or avoid taxes on this transaction.
Tiffany C. Wright has been writing since 2007. She is a business owner, interim CEO and author of "Solving the Capital Equation: Financing Solutions for Small Businesses." Wright has helped companies obtain more than $31 million in financing. She holds a master's degree in finance and entrepreneurial management from the Wharton School of the University of Pennsylvania.