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Gain or loss realized on the disposition of property
generally must be recognized as taxable under section 1001(c).
Disposition of property includes the involuntary conversion of
property through condemnation and damage. Rosenthal v.
Commissioner, 416 F.2d 491, 498 (2d Cir. 1969), affg. 48 T.C. 515
(1967). Section 1033 provides an exception, allowing
nonrecognition of gain realized under specific circumstances.
To qualify for the section 1033 nonrecognition, the gain
realized must have been: (1) Compensation for the involuntary
conversion of the taxpayer’s property and (2) expended within a
specified period of time for the replacement of the converted
property with similar property. Sec. 1033(a)(2)(A) and (B).
Here, the parties disagree about the $130,000 received in
settlement of petitioners’ claim against Allstate. Petitioners
argue that the settlement proceeds were compensation for the
involuntary conversion of their property and that the
compensation was expended for repairs to restore the house to its
original condition. Respondent argues that the payment cannot
qualify for section 1033 treatment because it was not
compensation for a property loss nor was it used solely to
replace the involuntarily converted property. If the payment was
to satisfy a claim for punitive damages, that portion would not
be “compensation” as required by section 1033. See Lukhard v.
Reed, 481 U.S. 368, 389 (1987) (“Punitive damages * * * are a
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Last modified: May 25, 2011