Take note that this is not a conversion of anything. It's a sale. Assuming that only real estate is involved (no structure is being sold) it's simply a sale of raw land, so to speak, that is/was a part of your primary residence. So this does have to be reported on your tax return. In order to determine if this sale is a gain or loss, you must first determine the fair market value (FMV) of that portion of the property being sold to the state. Then if your sale price is higher, you have a reportable/taxable gain. If lower, you have a loss. Losses on the sale of personal property are not deductible. I would fully expect your sale price to be "at" FMV, meaning no gain or loss.
Take note that you can not use your property tax appraiser value of the land as FMV. That's because the tax value assessed by thte property tax appraiser is solely for the purpose of determining your property tax paid each year. Typically (though not always) that value is on average, 30% lower than it's FMV on the open market. I would suggest you obtain an appraisal from a qualified, certified appraiser in your locale. The cost of the appraisal can be claimed by you as a sales expense. While the appraiser will survey and value your entire property inside and out, make it clear to the appraiser that you want them to include a value for that portion of land the state is purchasing from you. I assume the state is using imminent domain as a part of their actions to acquisition the property from you.
