I owed roughly 87k on a rental home that burned to the ground. I had replacement cost insurance on the property. The replacement cost exceeded the limit of the policy so they paid out 155k to the bank(lenders placed insurance-long story). The bank in turn paid off the loan and sent me the rest…roughly 68k. I had to incur the demo cost and cleared the rest-roughly 60k.
It’s my understanding, as of today :(, that I owe taxes on the 60k. But, I have 2 questions? First since the BANK was the payee on the insurance policy, do I still owe taxes? And also If I buy another property and use ALL the money to do so, do I still owe the tax?
Of course I dont want to pay the taxes LOL…but obviously, if I have to, I have to…just looking for other avenues??
What you owed is irrelevant in this scenario. The relevant fact is your basis in the property.
The amount of the insurance payout is deducted from your basis. Add to this the cost of whatever improvements or new construction costs to restore the property.
You have no gain or loss until you dispose of the property and calculate your gain/loss using your new basis as outlined above. Note that depreciation wonkys up the calculation a bit from my simple scenario.
Example: Your basis in the property was 200k. Insurance paid 155, so your new basis in a piece of sooty dirt is now 45. If you sold it tomorrow for 50, you have a 5k gain.
But let’s say you spend the 68 cash plus another 60 borrowed and rebuild a new house. Your new basis will be 173 (45+68+60).
If you never do anything, you keep the 68 cash tax free. It’s not “income,” rather it’s compensation for the loss of the property basis. The cash just gets you back to where you were before the loss. You have had no financial gain on the transaction.
[Note that you could have a gain, but only if the insurance proceeds are geater than your basis in the property. You may still avoid taxes by reinvesting the gain in the property. But this is a whole 'nother discussion…]
Who told you that you owe tax on the 68k? Kick 'em to the curb.
If you don’t mind, I’m going to use you for a facebook post tomorrow. Like my page and read all about yourself!
I have already demolished the house…Its a flat piece of land.
So your original basis is $73, and your insurance payout was $155.
I will assume that you either A) purchased the property below market value or B) experienced significant appreciation in value or C) have owned it a while so your depreciation is significant [this goes to the basis calc on disposition].
If it’s not one of these, then you need to re-look at your basis calculation (unrecorded improvements, for example).
At this point you’ve got $82 to deal with (155 - 73). Your basis is zero (technically negative). The land has some market value. Let’s say this is $20, just for our example.
You can:
- Dispose (sell) the land, and pick up the 102 income (82 + 20)
- Spend at least 82 to rebuild the property. Your basis in the new property will be the replacement cost minus 82.
- Spend at least 82 on a “similar” property. Again, your gain is deferred and your basis in the new property will be the purchase price minus 82.
- do nothing. keep the land at zero basis and pick up 82 income today.
- some combination. keep the land AND buy a new property, etc.
I think you’ve got 2 years to rebuild or replace. If you’re going to sell you should probably pick up 82 now, and take the gain on the land (zero basis) when you sell it.
In the end, you made $82 on the fire. That’s going to be income somewhere, sometime. Either today (sell the land and walk away) or later (when you sell the new property at the reduced basis).