This is eminent domain and is treated as an involuntary conversion. They have two years to purchase replacement property and defer tax on any gain. Also, if only a part of the property is taken and the property is their principal residence, they can exclude the gain under Sec 121 if the rest of the property is sold within two years. If they do not purchase replacement property, and the whole property was not taken, you have to allocate basis to it to determine the gain. If the entire property was taken the excess over basis is gain. If a portion of the property was taken and the sale is reportable, basis must be allocated between the taken and remaining property.