Basis of property

[Openfire]

This should be pretty basic, but I would love to have someone look over my shoulder on this.

Client sold house in MS. Purchased in 1996 for $156000, tornado blew it away in 2013 and insurance paid it off. Client received $225000. He did not rebuild. Sold the property in April 2016 for $171000. He had not lived in the house for 24 months after April 2011. He moved out and rented it in March of 2012 until tornado.

I believe he needs to calculate the stepped up basis of the property itself at the time of the tornado and then pay capital gains on the difference. However, this was investment property with no income for the last several years, so nothing was reported on Schedule E since 2012.

Thank you!

[mactoolsix]

From Pub 547:

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 isn't 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

So, to put some numbers to that:
The loss =
Adj Basis probably about $80K ??
MINUS
Salvage value 171,000
MINUS
Insurance reimbursement 225,000

About $300,000 LT gain.

Mike

[Openfire]

Thank you so much. My thought is that the insurance proceeds were calculated to make the client whole. He did not rebuild, therefore he did not have income from the rental, and was left with an empty lot. I believe the sale of the property now is isolated and only deals with the land itself. Wouldn't this sale only deal with the basis of the property at time of sale, and the realized gain only be on the land value?

[taxea]

Do you have a document that details what the insurance covered and paid for. I agree with you that at this point you are only dealing with the land. If the land value was not included in the insurance reimbursement I would.....allocate from the original basis the portion that was for the land. There is no depreciation involved for the land so your gain/loss is the land basis vs the sale price and any cost of sale.

Note: It was not investment property if there was no income producing involved once the house was gone.

[mactoolsix]

Do you have a document that details what the insurance covered and paid for. I agree with you that at this point you are only dealing with the land. If the land value was not included in the insurance reimbursement I would.....allocate from the original basis the portion that was for the land. There is no depreciation involved for the land so your gain/loss is the land basis vs the sale price and any cost of sale.

Note: It was not investment property if there was no income producing involved once the house was gone.

But there was depreciation that must be recaptured. And just because there was no reimbursement for land destruction, you can't ignore the insurance reimbursement. Well, I guess if he only sold the land rights and kept the right to build on that land . . . . . . .

I think you need to follow the rule laid out in the Pub.

[Roland Slugg]

That's an interesting set of facts, and there may have actually been two reportable tax transactions. The owner may not have lived in the house for the necessary 2-out-of-5 years before the sale of land in April 2016, but it looks like he did meet the 2/5 requirement at the time the tornado destroyed the building. Did he report that event as the "sale" of his personal residence on his 2013 tax returns? If not, I believe he could have ... excluding the gain if he met all the other requirements. He would have to make a reasonable allocation of his basis in the entire property, between land and building, based on their relative FMVs immediately before the tornado, then treat the building as sold in 2013 for the amount of the insurance proceeds, $225k. If he did not report that on his 2013 return, there is still time to amend his 2013 return and do so. I would certainly consider doing that.

That would leave him holding just the land, and its basis would be the allocated portion of the property's $156k cost in 1996. Then he sold that land for $171k in April 2016, and that would be a separately reportable transaction.

If he did not report the tornado event as a sale of his residence in 2013, and he doesn't want to report it now via an amended 2013 return, then he is left with a sale in 2016 plus insurance proceeds received (I assume) in 2013, totaling $376k, and resulting in a gain of $240k ($225k + $171k - $156k). The trouble with that is that the insurance proceeds portion of the overall series of events should have been reported no later than his 2015 return. See the rules for reporting gain from an involuntary conversion. (Code §1033)

Better discuss this with your client.