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Insurance proceeds from roof damage


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#1 mircpa

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Posted 03 October 2011 - 02:19 PM

Hello Seniors
I have a question for a client who owns single family residential rental property. Last year due to rain/hail damage, insurance company paid him $ 4,900.00 and taxpayer in turn spent $ 4,500.00 for roof repair. My understanding is to show $ 4,900.00 as other income on 1040 line 21 and capitalize/add to value of building for $ 4,500.00 for depreciation purpose. For all previous years taxpayer expensed insurance premium against rental income. Filing Sch E. Can somebody correct me if i am wrong.
thanks to all who responds
mircpa

#2 mlinder42

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Posted 03 October 2011 - 02:41 PM

The $4500 is not income he should not have to pay tax on insurance money.The rental is not worth more after the roof is repaired than before the roof was repaired.I would just net out repairs for the year with the insurance money.If this was his auto and it was in an accident you would not pay taxes on the amount of the insurance repair.I am amazed that the client said he did not use the total money to repair the roof.

#3 Pacun

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Posted 03 October 2011 - 02:49 PM

No one will question your approach.
I would add the $4,900 to schedule E on its own line instead of line 21 for simplicity.

Have you thought about the $4,900 being return of capital and reduce the basis of the rental property? I wonder what others think.

Keep in mind that insurances give you money to repair (or make it the way it was). The money is not intended to improve your house but to repair it from the damage

#4 schirallicpa

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Posted 05 October 2011 - 09:04 AM

The $4500 is completely covered. No expense to show. Certainly not an improvement - not depreciated. No income to show. The extra $400 goes un-reported. Insurance is not taxable income.

#5 mircpa

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Posted 05 October 2011 - 12:00 PM

Hello Seniors/friends
I just got down on phone with IRS, the correct treatment is to report this transaction on form 4684. This is FYI

thanks

#6 Pacun

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Posted 05 October 2011 - 12:28 PM

Share with us the end result... will you pay taxes on the $400 or you will just lower your basis or there is no tax consequences after your finish with form 4684?

#7 mircpa

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Posted 05 October 2011 - 08:22 PM

In this case insurance proceeds $ 4,900.00 minus replacement cost $ 4,500.00 leaves you with $ 400.00 gain on 4684 flows to Sch D

#8 jainen

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Posted 05 October 2011 - 10:50 PM

>>insurance proceeds $ 4,900.00 minus replacement cost $ 4,500.00 leaves you with $ 400.00 gain<<

It's a rare policy that will pay you MORE than your actual loss. Cost of repair is commonly used as a measure of the loss, but who says you have to completely repair it?

#9 mircpa

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Posted 06 October 2011 - 11:56 AM

Jainen
Here in this context, when I say replacement cost, it would be cost to repair.

#10 jainen

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Posted 06 October 2011 - 06:40 PM

>>when I say replacement cost, it would be cost to repair.<<

You said, "replacement cost $4500." That assumes more than was stated in the original post. Apparently the insurance company determined that the cost to repair was $4900. Perhaps the actual expenditure was less because they used less skillful labor or cheaper materials.

Suppose they didn't spend ANY of the insurance proceeds. Suppose the damage was cosmetic and the roof still didn't leak, so they just decided to live with a less attractive house. Would you include the $4900 in taxable income? Of course not, because it still represents the loss in value which is what insurance covers.

#11 mircpa

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Posted 06 October 2011 - 10:24 PM

What i believe might have happened is it might be a good insurance company and based on their adjuster's advise who might have estimated repair cost to be around $ 4,900.00 and gave the check to building owner, now building owner in turn might have found less skillful labor and inferior material to fix roof as you suggested. Your point about would I include income or gain of $ 4,900.00, yes only in circumstance where taxpayer might have got money from insurance company and pocketed without spending for repairs. Now value lost in property due to hail damage is quickly being restored to its original value by way of insurance proceeds

#12 jainen

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Posted 07 October 2011 - 04:58 PM

>>would I include income or gain of $ 4,900.00, yes only in circumstance where taxpayer might have got money from insurance company and pocketed without spending for repairs.<<

Here is how the IRS says to figure gain, on page 10 of Pub 547 at http://www.irs.gov/p...rs-pdf/p547.pdf. "The amount you receive [insurance], minus your adjusted basis." Where does it say anything about repairs?

In other words, insurance is treated as a basis adjustment, and ONLY counts as income after basis is reduced to zero. Then, money spent (if any) on repairs or replacement, whether from insurance or any other source, adds back new basis.

#13 mircpa

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Posted 07 October 2011 - 05:19 PM

Yes in fact IRS agent cited me pub 547 to figure gain or loss. Dont you think the situation you described applies in case when there is total loss to property, this was partial loss and we cannot consider adjdusted basis of complete property because property is still in use, it is not condemned. Therefore I think it is more realistic to figure loss or gain through this route, when money is being spent to get property in original shape what it was before it is getting its lost value back on top of that owners received more than what they spent to repair, therefore it is gain. $ 4,500.00 what is spent to get its value back and $ 400.00 is gain because owners got paid $ 4,900.00. $ 400.00 is excess money they received to get its value back to original shape.

#14 jainen

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Posted 07 October 2011 - 05:40 PM

>>I think it is more realistic to figure loss or gain through this route... excess money they received to get its value back to original shape<<

Personally, I think it is more realistic to follow the tax code. I'm flattered your IRS agent agrees with me. And besides, where in the original post does it say that $4500 got the property back to its "original shape"? Nowhere.

#15 mircpa

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Posted 07 October 2011 - 06:08 PM

You want me to explicitly state that $ 4,500.00 spent by taxpayer got property back in original shape ?. Spending $ 4,500 for repair will get back property to its original shape. I did emphasised in post 1, that this is repair money. Money spent on repairs if not original but will definitely get property close to original, If you have my way, I would say it will be better than original. Based on the facts stated, what do you think should be correct interpretation, or what would be your approach to properly record this transaction.

#16 jainen

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Posted 07 October 2011 - 06:59 PM

>>what would be your approach to properly record this transaction<<

A net basis reduction of $400.

#17 Pacun

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Posted 07 October 2011 - 08:00 PM

I think reduction of basis for $400 is the correct way. The insurance company pays to repair the roof, it is not an improvement.

I understand why this situation takes us off guard. A lot of questions on the EA exams mention that replacing the roof is a capital improvement and must be depreciated. Think for a moment that the insurance paid $4,900 because you house was flooded and you spent that amount of money cleaning and mold treatment. In the flood event, no one will think about capitalizing it.




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