Hazard Insurance Payment

[Tazcoins]

Question about Hazard Insurance on Rental Property.  I had a rental house damaged by Hurricane Michael in 2018.  When the insurance paid out the claim in 2019 for $75k, I found that this would not cover the rebuilding of the property.   So, I sold the property in 2019 for $100k in damaged as-is condition.  My cost in the property was $100k so it was sold for the same amount as the cost of the rental property.  Since none of the $75k was used in rebuilding the home, do I need to claim that as income for 2019?.

[JohnW222]

You may owe tax on the sale of your rental property, but it's unlikely that $75,000 is the amount of income you'll need to report.

When you sell an asset like a rental house, you have to compute your "basis" in the house to get a correct calculation of your gain or loss in the sale.

If you paid $100,000 for your property, then the insurance reimbursement of $75,000 would result in a decrease in your basis, meaning your adjusted basis would be $25,000, and your gain would be $75,000.

However… you most likely had some expenditures that added to the adjusted basis of the property (and thereby reduce your gain). 

Please see Table 1, Examples of Increases and Decreases to Basis, in the IRS's Publication 551, Basis of Assets.

Also see the TurboTax article Cost Basis: Tracking Your Tax Basis for more information.

[Carl]

As you know, the rental property insurance premiums you paid were deductible from the rental income. Because of that, any and all insurance payout is reportable income. It's also reported as passive income. That's because any income received from any source for any reason on rental property, is considered rental income. Period. Since you did not use the money to rebuild, you need to include that payout in the toal rental income you received in the tax y ear the payout was received.

The fact the property was damaged in 2018 does not change the fact that it was still classified as rental property in 2019 when you received the payout. Additionally, I can practically guarantee you that your policy payout included a "loss of rents" payment for up to 85% of lost rent, for at least 6 months.  But it really doesn't matter becuase the entire payout is reported as rental income on your 2019 tax return.

Now there are some things you need to do with the SCH E on the 2019 taxes, so as to reduce your tax liability on the payout as well as the sale. In a Nutshell:

All depreciation ***NOT*** yet taken on the structure gets added to the cost of the land, thus increasing the cost basis on the land. This will reduce your taxable gain on the sale while allowing for the "loss" of the structure for the depreciation not yet taken on it prior to the disaster that destroyed it.

The $75K insurance payout is rental income for 2019. Period.

THen you'll report the sale in the SCH E section of the program do that the program can do all the math for you.

If you need further guidance on how to do this in the TTX program, let me know and I"ll walk you through it.