Investors & landlords

@Anonymous:  The issue with the example you cite above is that that is the calculation for nonbusiness property. The reason why?  With nonbusiness property, you cannot get a deduction for any expenses related to restoring a property; they add back to the basis to bring the property back to it's original value.  And, I think @Carl would agree that the IRS' explanation of how the basis is reduced is convoluted.  If you see the math in the example, the initial reduction of basis due to the casualty is the full amount of FMV loss on the casualty:  the part that insurance reimbursed, and then the portion that was just "loss".  But the IRS' explanation just helps define how they calculate the reduction.  You must reduce the basis by $4300 in insurance reimbursement because you "sold" this portion of property (for lack of a better expression).  Since this "sale" (to insurance) is a return of capital on the initial value of the property, it's not taxable money, but when you spend that money to restore the value of the home, you in essence buy the basis back.  (And the same applies to the "casualty loss" portion:  when you claim that on the tax return, you have "cashed in"  on its value and thus it reduces the basis, which paying for the restoration restores).

But when you are dealing with property for business use the situation changes completely, because of required depreciation (which, by the way, also reduces the basis on the property, which is why this gets complex).  So, using the example above you give, when the property is put into business use, it had a depreciable value of $25,000.  Let's say, just for argument's sake, that the property has depreciated for two years and you have already claimed $5000 of depreciation in those two years.  (The real numbers would be different, but it's easier to see with square numbers).  Then, in year three, the casualty loss occurs.  Because this is a business use property, you can choose to deduct the repair expenses (which are not capitalized, by the way. Repairs that restore a property's value are deductions.  Improvements and renovations which add to the value of the property are capitalized).

So let's say you decide to do that.  The insurance has reimbursed the casualty loss, so you don't claim the loss, and the insurance is not income (because it is being used by the loss).  The remaining portion of the loss is covered by claiming the expense you paid, so you wouldn't claim casualty loss.  But because you are claiming the expenses, this is where the complicated depreciation begins.  As stated above, depreciation also reduces basis.  So, if your original basis was 25,000, and you've taken 5,000 at the time of the casualty, the property's depreciation basis also drops to $20,000.  And now you have to synchronize this new depreciation basis with the current depreciation schedule.  You do not simply "start over".  Rather, your third year depreciation will be calculated as having a basis of $20,000, with $15,000 of remaining depreciable basis.  Which is why the IRS says you then have to go to the depreciation tables to find out what the percentage of depreciation is on the $20,000, and then subtract from the $15,000 to determine what basis is remaining in year 4.

As Carl pointed out, TurboTax doesn't handle this well (and I don't know of any software that does, frankly).  So for your situation, the easiest thing to do is to not claim any of it.  Do not claim the expenses, do not claim the insurance reimbursement, and do not claim the uncovered casualty loss.  It's not worth the trouble to recalculate your depreciation for such a small amount when it will work itself out in the end.  Either through depreciation you will eventually use all of this value on your returns, or at the time you sell the property you will have a higher basis (in effect), which will reduce your capital gains (and depreciation recapture); either way, the net result of what ends up getting claimed to the IRS is the same, which is what they are most concerned with.  And if this were audited, you have a defendable position.