Rental Fire

[Steve M]

Client was selling rental house. 2 weeks before closing, house burned down. Insurance covered the loss. He asked me for advice and I want to be sure that I am correct.

There will be no tax consequences until he sells the property if ever? Yes or no?

When he sells, he will add the insurance proceeds and property value together and that will be his selling price. He then adds in his depreciation taken to get a final selling price. Is that the correct way to handle it or am I missing something else.

smacica

[OldJack]

Wrong! Yes you are missing everything.

In the tax year he had the fire, he files a casualty loss, tax form 4684, reporting his insurance proceeds and tax cost basis to determine if there is taxable income or a loss deduction.

[kcjenkins]

Sorry, Steve, you are way off base on this one. He reports, as Jack said, the fire loss and the insurance proceeds, in the year of the event. Your thought was logical, but not how the tax code looks at it.

[jainen]

>>how the tax code looks at it.<<

Once again, I see it differently. There was no casualty loss because it was covered by insurance. Instead, he has an involuntary conversion. He can report gain/loss on Form 4797, or file an election to defer gain for up to two years. If he rebuilds or buys new property, the tax effect might indeed be similar to what the original post suggested. Steve's wording was awkward, however, so I recommend researching Section 1033. Start with Pubs 544 and 547.

[Elrod]

Aaaaaaaaaaaa.......Fire ain't a casualty...........I beg to differ.....I'd go with OLDJACK...............

[jainen]

>>Aaaaaaaaaaaa.......Fire ain't a casualty.<<

Casualty, yes. Casualty LOSS, no. I can't guess the numbers except the original post did say, "Insurance covered the loss." Generally insurance pays replacement value, often even with building code upgrades,. In this market that might very well exceed FMV, which is all you can base a tax loss on. And with rental property depreciation further reducing adjusted basis, he may have a taxable GAIN.

That's why I don't think Steve was "missing everything" and "way off base." I think he was very close if not dead on. (But a good cynic plays both sides, so I can't help wondering what the fire investigator had to say about the convenient timing.)

[BulldogTom]

The problem with this thread is the original post does not say what happened to the insurance proceeds. It also does not say if the property will be sold as land or if it will be sold as a rebuilt home on the land. The question leaves way too many options open to interpretation. That is why I stayed out.

But I am enjoying the back and forth about what a fire is. President Clinton would appreciate the banter over "what the definition of fire is".

Tom

Hollister, CA

[Elrod]

Yep...Me 2...

[Steve M]

Sorry I came back in this late; I couldn't find the thread and thought no one had answered. Obviously that's not the case.

the client has not decided what to do with the property yet; it may depend upon what the tax consequences are. Other than a deductible there would be no loss to claim on 4684 and that will not meet the threshold. If he sells just the land, my assumption would be that the insurance proceeds would be included in the sale price plus depreciation less the deductible. But if he rebuilds and sells, I would think his basis would be the original basis plus depreciation. But if he claims the sale this year (even though he doesn't sell this year) What happens tax wise if he sells it next year for the same amount. If he is issued a 1099 for the sales price in a future year, IRS will think it is a second sale. Even if the new basis and sales price are the same, it would still appear as a second sale.

Thanks for your help anyhow.

[jainen]

>>Other than a deductible there would be no loss<<

The deductible is NOT a loss, and in fact is irrelevant to the tax position. First determine the reduction in FMV; presumably two weeks before closing there was a reliable appraisal separating land from improvements, although some improvements such as paving may not have been destroyed. Compare that to insurance proceeds, regardless of how calculated, to see if there was a gain or loss.

Next determine basis for sale. Add demolition costs to the non-depreciable land basis. Subtract depreciation from the original basis of structure, make any other basis adjustments, and further reduce (but not below zero) by the insurance proceeds. Increase by any reconstruction costs. Later, compare that to the actual sales price.

Tax-wise he is in good shape. He didn't have to sell in a depressed market, facing capital gains tax. Instead he can elect to keep the property waiting for higher prices in the next two years, but without any tenant hassles. Meanwhile he has a ton of tax-free cash he can use for anything, including new property that will defer capital gains tax forever!

[JohnH]

Or he could go on vacation with some of the money. . Maybe meet another landlord who is vacationing on part of the proceeds from HIS property being destroyed by a flood. For future reference, they can spend time discussing how to start a flood.

[Elrod]

Don't forget the cost for material to build an Ark.