How to report an Involuntary conversion which resulted in a gain on a Principal home that is less than the section 121 exclusion

[pabolger]

My main principal home was completely destroyed in Federally declared disaster (with a DR#) on 12/30/21.

My insurance proceeds( both received, and projected to the limits of the policy) will exceed the adjusted basis on the lost home by $194,000. So a gain was created as an involuntary conversion.

The IRC section 121 exclusion for a single owner is $250,000.

I have owned the home for the last 12 years.

I received no 1099s from my insurance company.

And have never taken the exclusion.

I just attempted to complete for 4684 in the disaster/Theft section of Deductions & Credits. But it appears that this is not necessary because the instructions say "If you exclude the gain and the entire gain is excludable, don't report the casualty on Form 4684."

So I deleted the property I listed from the 4684 form.

I believe this is correct.  Is it?

My question is:  How do you report the insurance proceeds Involuntary gain if I wish to use the 121 exclusion.

It is not a Home Sale.  

I am rebuilding  a replacement home on the same lot to be completed by 12/1/23 for a higher amount than my insurance proceed.

So I believe the best I can do is create and attach a separate  clear note (with specifics) to the IRS explaining that my Insurance proceeds exceed my adjusted basis, but the gain is less than the section 121 exclusion.

I feel must report this is some way.

Does that approach work?

If so, it appears I must mail my 2022 return to the IRS with this addendum as Turbo tax does not allow pdf attachments.  Correct?

Is there a way to file my return electronically with a proper accounting?

[MonikaK1]

Under the circumstances you describe, you don't need to report the gain from the involuntary conversion of your residence due to a Federally declared disaster. 

An involuntary conversion occurs when your property is destroyed, stolen, condemned, or disposed of under the threat of condemnation and you receive other property or money in payment, such as insurance or a condemnation award. Involuntary conversions are also called involuntary exchanges.

Involuntary conversions of private homes are an exception to the rules. According to the IRS, if the property you lose to involuntary conversion is your primary residence, generally, you will not have any tax consequences, even if you don't purchase a new home and realized a capital gain or loss.

Even if you were to sell the home and the sale resulted in a gain less than the 121 exclusion amount, you would not be required to report the sale on your tax return (unless it was reported on a Form 1099-S, for information return matching purposes).

See this article for more information from TurboTax on involuntary conversions.

See here for more information from the IRS on involuntary conversions.

[pabolger]

Thank you for you prompt reply.

Couple of questions:

1.  Is it necessary to mail in my 2022 return with an explanation describing my case?

This would significantly slow down my rebate,  but it would "record" my intensions.

Is the addendum a requirement for the IRS to complete a proper filing?

or,  can I simply do nothing, (either on form 4684 or as a home sale with exclusion),  and submit my turbo tax file electronically without any mention of the insurance proceeds received.  I would then simply keep accurate record in my files showing the proceeds, and and adjusted cost basis-- for backup purposes only.

2. If I used the section 121 exclusion on my lost home's involuntary conversion gain, I assume that the basis on my new replacement home starts over.   That means my basis would be:  the land value + cost of construction when I move in.  jSo my lost home's basis dies and does not carry forward.  

And I must live there 2 years to earn another $250,00 section 121 exclusion.

Is this correct? 

Thank you for your time.   You are really helping me with a  very stressful situation.  

[ShirlynW]

Yes, a new cost basis will apply for the new replacement home if you use Sec. 121. Yes, you must meet the period of ownership (two years) to claim Sec. 121 again.

IRS Pub. 544, page 6 explains an involuntary conversion occurs when your property is destroyed, stolen, condemned, or disposed of under the threat of condemnation and you receive other property or money in payment, such as insurance or a condemnation award. A gain or loss from an involuntary conversion of your property is usually recognized for tax purposes unless the property is your main home.

Sec. 121 allows individuals to exclude a gain of up to $250,000 ($500,000 if married filing a joint return) from their gross income on the sale or exchange of their principal residence. If the taxpayer excludes a gain under Sec 121, the taxpayer does not adjust the basis of any new home acquired due to the exclusion. To use the exclusion, the taxpayer must have owned the home and used it as a principal residence for a period of, or periods totaling, two years or more within the five years before the sale or exchange. The periods of ownership and use do not have to be concurrent.

[pabolger]

I just want to be clear.  When you say that "I don't need to report the gain from the involuntary conversion",  That means that I do not enter anything either into Form 4684.  And I would not enter anything into the routine where I "sell" a home.

I have written a very clear explanation of why my insurance proceeds and other reimbursements,  cause a gain less than the section 121 exclusion.

My plan is to take the exclusion, and move to my new replacement home with a totally new cost basis.

Is it necessary to attach this addendum to my 2022 return?  

Or should I just keep the detail and summary in my files.  

If it is, my understanding is that Turbo tax can not attach a pdf of the addendum to the 2022 return.

If the attachment is necessary,

I believe my only option is to mail the return to the IRS, and therefore cause a large delay in receiving my refund.

Aside from this involuntary conversion my return is very straight forward, much like in years past.

or

Can I file the 2022 return electronically to speed the refund.  And then put the return in the mail, with the addendum.

Sorry for the detailed questions, but I am stalled on what to do.

Can you help me move on.  I am ready to file.

[Cynthiad66]

You should be able to e-file your return now.  You can keep the addendum for your records if the IRS should need additional information.

Do Not mail the return after e-filing.  That is like filing twice and you do not need to add that confusion.   Just hold onto your copy with the addendum for your records.

You should be able to e-file your return if everything is ready.

@pabolger