Insurance compensation

[NotEasy]

Client's rental property was partially damaged when an accident happened last year. They received a compensation from the insurance company. But they also spent most of the compensation to repair the property.

Supposed the compensation is $10,000 and spent $9,000 to repair the property. How would you report it?

(1) Report $10,000 as income on Schedule E and claim $9,000 as expenses on Schedule E.

(2) Offset it and report $1,000 as income on Schedule E, no expense claimed.

Which is the correct way?

[taxea]

nope...you only report this type of loss if you are out of pocket for any of the expense to replace the loss.
The IRS does not require you to report as income any insurance payment that exceeds your costs.
Frequently the insurance company will send a check based on the value of the loss. With any loss/damage you are not required to replace the item. The insurance payment is compensation for the value of the item/s. Like a totalled car...nothing requires you to replace or repair it, but the insurance company pays for your loss. Look at it as a reimbursement for the item. It is your choice whether or not you replace it. The insurance money, either way, is not taxable income.

[NotEasy]

nope...you only report this type of loss if you are out of pocket for any of the expense to replace the loss.
The IRS does not require you to report as income any insurance payment that exceeds your costs.
Frequently the insurance company will send a check based on the value of the loss. With any loss/damage you are not required to replace the item. The insurance payment is compensation for the value of the item/s. Like a totalled car...nothing requires you to replace or repair it, but the insurance company pays for your loss. Look at it as a reimbursement for the item. It is your choice whether or not you replace it. The insurance money, either way, is not taxable income.

Can I take what you said to mean that the reimbursement is not rental income. But if the property owner used the reimbursement to repair the property, it is rental expense?

Now I think the taxpayer may actually need to file a Form 4868 for casualty loss and also report the reimbursement on that form. Does anyone agree or disagree?

[Gary2]

Can I take what you said to mean that the reimbursement is not rental income. But if the property owner used the reimbursement to repair the property, it is rental expense?

Now I think the taxpayer may actually need to file a Form 4868 for casualty loss and also report the reimbursement on that form. Does anyone agree or disagree?

A 4868 this time of year? It's still February.

I think you mean 4684. And yes, start there in section B, and follow the instructions to see whether or not you have reportable income.

[Gretel]

Since this issue keeps coming up and I will have to deal with this myself soon I looked closely at the 4684. If there is taxable income depends greatly on the basis in the property.

What I still don't understand is what, if anything, happens if you still have enough basis to not end up with a taxable gain. I thought you need to adjust your basis but find no reference for this. Does this mean you do not have to adjust your basis if you receive more insurance reimbursement than what you spend for repair/replacement, but have enough basis to not have a gain?

[S T]

Here is another thought

Property owner pays for Insurance to cover certain damages - Insurance sends adjuster, adjuster determines the amount of the loss and then due to "whatever limits" has the company issue the check "in this case for $ 10,000" to the t/p - policyholder. (Insurance Company does perform the repair or remediation work)

T/p then says thank you very much, but is able to have the repairs (not capital improvements) completed for less than what the Insurance Company ( $ 9K) Paid

T/p is now $1,000 to the good - and is this income???

Since it is for repairs or loss or rents (not capital improvements to reduce basis) I am thinking it still needs to be reported on 4684 somehow, or in the alternative on the Schedule E.

Theory is that Schedule E does take deduction for Insurance Premiums for coverages each and every year - payouts then would be income offset by expenses.

If loss of Rents covered under my Landlord's policy were received, would I not have to claim that as Income?

Sandy

[taxea]

How is there any taxable income out of the insurance payment? It covers the damage and the loss rent....nothing is taxable even if the insurance paid more than the costs and loss rent.

Unless the TP had additional expenses, over the amount of the insurance check, for repairs those would be deductible as rental expenses.
Formula
Insurance check minus loss rent=balance remaining minus repair expenses and depreciable items=this amount would be deductible as an expense.

[Gary2]

Property owner pays for Insurance to cover certain damages - Insurance sends adjuster, adjuster determines the amount of the loss and then due to "whatever limits" has the company issue the check "in this case for $ 10,000" to the t/p - policyholder. (Insurance Company does perform the repair or remediation work)

T/p then says thank you very much, but is able to have the repairs (not capital improvements) completed for less than what the Insurance Company ( $ 9K) Paid

T/p is now $1,000 to the good - and is this income???

No. The deduction for the casualty is for the loss, regardless of whether or not it's repaired or replaced. So is the insurance reimbursement. The repairs are only useful for determining the change in fair market value, or for postponing gain, but they're not used to determine whether there's a gain or loss.

However, the repairs and insurance factor into the basis adjustment. Let's assume the adjusted basis before the casualty is $50K. If you use the repairs as a measure of the decrease in FMV, then the casualty loss effectively balances the repairs, but the extra $1K is a basis reduction. The way it works on the 4684 is that there would be no casualty loss (but you still report it), because the insurance exceeds the loss. There's no gain to report, because the reimbursement is less than the basis. The basis would be adjusted down by $10K because of the reimbursement, then back up by $9K because of the repairs. (That the repairs wouldn't normally be capital improvements doesn't matter for casualty losses - as long as they're about restoring the property to its original condition.)

If the reimbursement is in a different year than the claim, then it could be a taxable recovery - which is a different scenario.

See Pub. 547, and work through some examples on form 4684.

Since it is for repairs or loss or rents (not capital improvements to reduce basis) I am thinking it still needs to be reported on 4684 somehow, or in the alternative on the Schedule E.

I'm not sure, off the top of my head, about insurance for lost revenue. But I expect they get different treatment, probably as business income. But don't combine the two types of reimbursements.

[S T]

Thanks Gary2, that explains what I was thinking out loud about, and probably di not express correctly, I was not sure about basis adjustment -

So we should effectively report on 4684 - if in fact we are dealing only with Insurance reimbursement for repairs only - Not loss of Rents -

and yes we will look at the Rental Income replacement through Insurance as a separate issue and how to report, as would not be a separate income issue?

Sandy

[Gretel]

Gary2, under the assumption that the basis is greater than $1,000, I agree with you that there is no income. The basis adjustment makes sense, even though I still need to find the reference.

However, if basis is zero then there would be a taxable gain of $1,000, right?

[Jesse]

I'm not sure, off the top of my head, about insurance for lost revenue. But I expect they get different treatment, probably as business income. But don't combine the two types of reimbursements.

I agree, if your business is interrupted and you receive insurance reimbursement for payment of the lost revenue from your business it is taxable income. I would think reimbursement for loss of rental revenue would also be included in your income, no?.

[Gary2]

Gary2, under the assumption that the basis is greater than $1,000, I agree with you that there is no income. The basis adjustment makes sense, even though I still need to find the reference.

However, if basis is zero then there would be a taxable gain of $1,000, right?

There's a taxable gain of $10,000 (reimbursement minus basis), of which $9,000 can be deferred under these circumstances. Make sure the repairs meet the rules. Pub. 547 didn't seem to explicitly address repairs as replacement, though there is one example that mentions rebuilding a house. In this case, I believe it's key that all the repairs were required or at least incidental to restoring the property to the original condition.

For example, vandal breaks a window. Replacing the window counts. Replacing all the other windows doesn't. Replacing the original cheap window with a high-efficiency window requires more research. Replacing the alarm sensor on the window counts. Having to replace the wiring to the sensor, because the new replacement requires different wires but is otherwise comparable, would also count - since it's required for the repair even though the original wires weren't actually damaged. (As an example, it's a stretch - I can't imagine ever being forced to replace undamaged alarm wires without replacing the entire system - but it's the best I can come up with on short notice. The point being that some repairs could legitimately force replacing things that weren't actually damaged.)