Any takers? Casualty again

[Snaggletooth]

If anyone is still interested in the Casualty post from a couple weeks ago, forget it. As is often the case, after I gathered the facts, they are much different than I anticipated.

The house destroyed by Hurricane Sandy suffered a whopping loss. It was a rental house, and the proceeds from the sale was only $66000 after lawyers and everyone else took their part. After all the calculations, the taxpayer ends up with a $45K loss. Selling price was $75,000, taxpayer had
adjusted basis of some $120K. And this doesn't count the loss in FMV, some $300K.

HOWEVER, taxpayer had taken out a large equity loan to support a failed business some years back. In addition to dribbling out $66K to the taxpayer, the insurance company also paid off this home equity loan to the extent of $120K.

My question is thus: does the $120K loan payoff have to be added to the proceeds of the sale? If so, this will create a gain. Gain may be postponed for 4 years because of disaster area, but the woman is elderly and will not be buying a new house.

Under most circumstances the payoff of a loan is treated as proceeds of the sale. However, the loan had no purpose for the house at all, and was made to keep a business afloat for 5-6 years of losses.

Anyone care to offer an opinion??

[Gary2]

Was the loss declared on 4684 in the year it occurred (or the prior tax year, assuming the disaster rule is applicable)? If so, the insurance reimbursement is treated as a recovery.

If the 4684 was deferred pending insurance, the reimbursement needs to be included on line 21 of Form 4684. This will affect the calculation of realized gain or loss prior to the sale, which will probably be recognized on 4797. I haven't thought it through enough to know whether the rules for deferring gain come into play if the property is sold later in the same year that the casualty is reported.

Note that even if the bulk was deferred pending reimbursement, the amount not covered due to the deductible should have been reported for the year it occurred (or prior under disaster rules). I don't know if there are any rulings in a situation where one is sure there will be some significant reimbursement but no idea of exactly how much.

[Snaggletooth]

I'll Repeat the Question

Thanks Gary for your usual keen insight. FYI, The occurence was in 2011 but the haggling with the insurance company wasn't over until 2013. I am reporting the sale on 4797 and the casualty on 4684 in 2013.

The question, however, revolves around the payoff of the large home equity loan. The loan had nothing to do with the house(other than collateral), originally bought in 1966. A thirty-year loan covering the original cost of the house would have been paid off in 1996. The large loan balance had more to do with a failed business.

Given the facts above, must the payoff of the loan be included in the proceeds of the sale?

[Burke]

I believe it does to the extent the insurance company paid it off in the process of satisfying the claim. Regardless of the purpose of the loan, the house was collateral for it, and the total amount paid out by the insurance company for the TP's benefit was $66K + $120K, or a total of $186. This would be considered the amount received.

[Nashville]

It can get worse

Given the facts above, must the payoff of the loan be included in the proceeds of the sale?

If the loan payoff is not associated with the house, then it might become associated with the former business. If so, would this be a cancellation of indebtedess? I don't see how if the indebtedness is paid off. But it still might be considered income.

[sandigi]

It sounds like income

I was thinking the same thing as Nashville and Burke.

It sounds like income somewhere. Better on the house than the business.

Insurance recovery was 186,000
Rental house Basis 120,000
Gain 66,000

I was looking further for Form 4684 info and now I wonder do you have a casualty loss?

http://www.irs.gov/publications/p547/ar02.html

Copied from link:
Business or income-producing property. If you have business or income-producing property, such as rental property, and it is stolen or completely destroyed, the decrease in FMV is not considered. Your loss is figured as follows:
Your adjusted basis in the property
MINUS
Any salvage value
MINUS
Any insurance or other reimbursement you
receive or expect to receive