Tornado

[tonia2021]

Probably a simple answer out there for this simple question.

How does a taxpayer deal with insurance proceeds due to a natural disaster - like a tornado. In this case the taxpayer's entire house was a loss and insurance proceeds were recevied.

This taxpayer also received insurance money for damade done to a farm building.

I am assuming that the two items are treated differently since one is her house and the other is business property.

Thanks

[Koss]

Casualty Loss

You'll have to prepare two separate Forms 4684.

One will be for the primary residence, and will flow to Schedule A--unless of course the taxpayer somehow made money from the loss.

The other one will be for the farm building, and it will flow to... well, to "the applicable line of your tax return." That could mean Schedule F, or it could mean some other tax return altogether, if the farm is a corporation or a partnership.

Think mortgage interest on Schedule A versus mortgage interest on Schedule C... or something like that.

Only in accounting and taxation can you actually say something like "made money from the loss" and still have it make sense...

Burton

_____________________________________
The map is not the territory...
and the instruction book is not the process.

[tonia2021]

I now have some more information regarding the tornado damage to the house. The house was built by the taxpayer approx. 45 years ago. She thinks they spent around $27000. The house was a total loss. The insurance proceeds from the house is approx. $100,000. Does she have a taxable gain? Could she somehow qualify for the home sale exclusion, or does she have to pay tax on the difference?

[Koss]

Casualty Loss

Is she planning to rebuild?

Or is she going to buy another house, somewhere else?

This is going to get really complicated really fast.

There are special rules that apply to casualty losses in Presidentially declared disaster areas. There are different special rules that apply to cases where, as a result of a casualty loss such as a fire or tornado, the local government condemns the property and orders the owner to tear it down.

There is a way to postpone the gain, to give her time to purchase replacement property. The replacement property can probably be any other house that becomes her primary residence. It certainly does not have to be a new house built on the same lot.

You'll need to get more info from your client, and take a long look at the instructions for Form 4684. Also, see Pub. 547, Casualties, Disasters and Thefts.

If your client asks why this particular return is taking so long, you can simply tell her that her situation is very unusual, and that you are totally blown away by the complexity of the matter...

[tonia2021]

The taxpayer isn't going to rebuild or reinvest. She is about 85 years old and is going to live with her daughter.

[Koss]

Gain on Casualty Loss

I've done a little digging on this, 'cause it's kind of interesting... and it's not looking good for your client. Her basis is probably not $27,000. That figure can be adjusted to account for improvements over the years. But that will only help so much. She's still going to have a sizable gain.

I don't see any way to qualify this for the home sale exclusion unless she rebuilds.

What's going to happen to the lot? Does she plan to sell the land?

She has a replacement period during which she can postpone the gain until she either rebuilds the house or buys another house. You said your client isn't going to do that. But she may want to make an election to postpone the gain, and take some time to think about it.

What I'm suggesting here may sound ridiculous. For an elderly person who has lived most of their life in one home, and then had that home destroyed by a tornado, well... I can see why she has no interest in rebuilding or buying a new home.

But there could be thousands of dollars to be saved in taxes. And she may not even have to live in the new home.

I'm not kidding. She should have something built on that lot and then sell it. The replacement house will be treated as her main home, and even if she never moves into it, it will qualify for the home sale exclusion because it is considered a "re-incarnation" of the home that she lived in previously.

And this interpretation might even be viable if she were to sell the empty lot and buy some other house, rent it for one year, and then sell it. We'd have to dig further into this, and actually read parts of the IRC.

It seems fundamentally unfair to tax her on the gain when she was forced out of her home by the casualty. The problem is right now, she's not selling her main home. She's selling a piece of land that is left behind after her main home was destroyed. So she's not being taxed on the gain on the sale of her home. She's being taxed on the gain that arose from the fact that she received an insurance reimbursement that far exceeded her basis in the property that was destroyed.

She can't sell her main home, and exclude the gain, if her main home no longer exists. But if she replaces her main home, then she can sell it and avoid taxation on the gain...

That's my take on this so far.

[Koss]

Oooops... Here's an update

I apparently skipped over a very important paragraph in Publication 547. Here's what it says:

Main home destroyed. If you have a gain because your main home was destroyed, you generally can exclude the gain from your income as if you had sold or exchanged your home. You may be able to exclude up to $250,000 of the gain (up to $500,000 if married filing jointly). To exclude a gain, you generally must have owned and lived in the property as your main home for at least 2 years during the 5-year period ending on the date it was destroyed. For information on this exclusion, see Publication 523. If your gain is more than the amount you can exclude, but you buy replacement property, you may be able to postpone reporting the excess gain. See Postponement of Gain, later.

She's off the hook.

[tonia2021]

Thank you very much for taking the time to do this research. I am self employeed, with no employees, and I love the fact that there is a place like this to bounce questions off other accountants.