Rental property fire question

[amycp7]

Hi - If I stopped renting my property in June because there was a fire and they had to rebuild the home, do I put in my taxes I stopped using it as a rental property in June? Although, I did receive rental property losses from the insurance from June till the end of the year, so would it still be considered a rental for all 365 days or not? 

[Carl]

To save us both time, since the tax filing deadline is approaching, please download and read the attached word document. I wrote this document about 3 years ago. So if you suspect something may be outdated due to tax law changes then by all means, please question me about it.

[bgray052299]

Thank you Carl for the helpful document. If the structure burned down, we received insurance payment and then sold the land, where do I report the sale of the land? Is it okay to add in the unclaimed depreciation of the structure into the cost basis of the land for the purpose of the sale? If so the sale will show a significant loss which will hopefully offset the gains of the insurance payout vs the structure cost basis. Thank You!

[DianeW777]

No you cannot add the unclaimed depreciation from the structure to the land.  The reason is because it is part of the cost basis being used to determine your overall casualty gain or loss due to insurance proceeds.

The land should have had a portion of the cost of the entire property when it was first placed on the depreciation schedule.  You can use that amount if you actually set aside a land value at the time.

[Carl]

If the structure burned down, we received insurance payment and then sold the land, where do I report the sale of the land?

Is it okay to add in the unclaimed depreciation of the structure into the cost basis of the land for the purpose of the sale?

It depends on how you're reporting the casualty loss and insurance proceeds.

Basically, the insurance payout is reported as rental income. Yes, it's reportable and "potentially" taxable income. That's because you got to deduct the insurance premiums you paid in the past. Therefore, any payout of that policy is reportable on your tax return. Now I'm assuming you know and understand this, and that you also are aware of and understand quite a bit more, which I"m not going into here. So I'm only going to address your question.

If you declared the loss in the Casualty/Thefts section under the Deductions and Credits tab ***AND*** you heeded the guidance in the "learn more" links in that section and reduced your cost basis of the loss (that would be the cost of the structure only) by the amount of depreciation already taken, then the remaining depreciation you have not yet taken gets added to the cost basis of the land. Depending on the amount we're talking about here, it "may" offset the taxability of the insurance payout, or a portion of that payout. It's also perfectly feasible that your sale when combined with the insurance payout (or taxable portion thereof) you will actually show an overall gain on the disposition of the property.

[bgray052299]

Thanks Carl! Yes, I'm declaring the loss on form 4684 (Casualty and Theft worksheet), which transfers to 4797, and I reduced the cost basis by the depreciation that has been taken on the structure up to the date of the fire. I also entered the insurance reimbursement on for 4684. These figures drove a significant tax liability (not surprised). So then we sold the land roughly 6 months after the fire. Do I enter this sale on another 4797? This is where I'd like to add in the unclaimed depreciation value of the structure to the cost basis of the land as that will show the sale of the land was for a loss and helps reduce the tax liability of the large gain from the insurance reimbursement vs the structure value. 

Would it be easier to only "sell" this complete property and say the sale value was the insurance reimbursement plus the land sale and use the full land and depreciated structure value as the cost basis? 

Thank you for the help!

[Carl]

Would it be easier to only "sell" this complete property and say the sale value was the insurance reimbursement plus the land sale and use the full land and depreciated structure value as the cost basis?

I don't see why not. But then, you'd have to delete everything from the Casualty/Thefts section.

Typically for someone in your situation, provided everything from the date of the fire to the closing on the sale, occurs in the same tax year, your suggested method would work just fine and I can't think of anything that would raise any flags. That is, unless your state taxes personal income. The state is going to become aware at some point  (if they haven't already) that there's a tax basis change in the property because of the fire. So I would not use the above method you suggest, if your state taxes personal income. Remember, you're reporting the sale of the entire property. The buyer is reporting the purchase of land and "maybe" the purchased of a devalued structure. So the state is going to learn about this rather quickly, I would think. Exactly how the flow of information would work I this, I haven't a clue. I tend to avoid those things I"m clueless on... and least once I'm self-aware that I'm clueless. 🙂

Additionally, if the fire loss and the sale occurred in the same tax year, there's no need to convert the property to personal use before the sale. That's because a portion of your insurance payout is for "loss of rent". A fairly standard part of almost every rental dwelling policy, is a "loss of rent" clause which usually pays up to 85% (or less) of rent income loss due to the casualty, for anywhere from 6 to 12 months. Most common I see is for 6 months. So the fact may be, that your insurance company continued to "rent" the property, for a period of time after the fire. If so, the property remains classified as a rental.

[bgray052299]

Thanks @DianeW777  and @Carl , yes, the land and structure had values assigned when the property was acquired. Only the structure value has been depreciated since we obtained the property 2 years ago. So the cost basis for the casualty loss is the structure value minus the depreciation that took place up to the date of the fire.

Now that I've said that (not sure why this didn't sink in before), I realize that cost basis (depreciated structure value) is offsetting the insurance reimbursement. So the only cost basis for the land sale is the designated value we assigned when the property was acquired. There is no unused depreciation for the structure because it was used on past taxes or against the insurance reimbursement. I think my only question then is where I report the sale of the land as I already said the property was "disposed" on the date of the fire for the casualty loss, or maybe that is wrong?

Thank You!

[bgray052299]

@Carl This is helpful as we did receive rent from insurance through the date of the land sale, and therefor I can push out the date of disposition to the date of the sale. I had already entered the insurance "rent" as rental income. Everything happened in the same year, so that is good. I agree the state would get conflicting sale value information, but I have the paperwork to support all the numbers, so worst case is an audit and I can get advice on how I should have entered it all:-) You can tell I'm not afraid to dive right into the things I'm clueless on, LOL, but thank you for the help!

[Carl]

I realize that cost basis (depreciated structure value) is offsetting the insurance reimbursement.

That depends on how you're looking at it.

If you look at it as if you sold the structure to the insurance company, then your gain/loss on the sale is the depreciated value of the structure against the "sale price" the insurance company paid. If the insurance was more than the depreciated value, you have a gain. If it was less, you have a loss. More than likely though, my bet is you have a gain.

There is one catch though if you just report the whole thing as a sale, with your sale price being the total of what the insurance paid, plus what you got the the land. If sold at a gain, you need to show a gain on both the structure and the land sale. Likewise for both if sold at a loss. The reason you have to do this with TurboTax, is because the program sometimes has issues with doing the math correctly on the depreciation recapture. So if you have a gain on some assets in the group, and a loss on others, the program "might" do the math correctly. Then again, it might not. It just depends on what the actual numbers are. (cost basis, depreciation amount, sales price, sales expenses, etc.)  But the real pain is if the bottom line numbers aren't right, but the math works, then as far as the program is concerned, all is okay. So nothing gets flagged on the final error checks performed just before you e-file. It all has to do with the taxation of the recaptured depreciation.

[JadeDragon64]

Your word document is absolutely fantastic that answered most of my questions. At the end of the Word document, you mentioned that you would write another article to address the situation that the rental property is partially burned. Would you please share your that article? 

I have a duplex that half of it was burned in July 2023 and both side became uninhabitable. While the side that was burned was still in the process of rebuilding, the other side was duplex was cleaned and have tenant moved in on December 1, 2023. The burned side of rebuilt and will have tenants move in from April 1, 2024. I am sure your other article will provide tremendous help on my situation. 

[Carl]

Just treat and report each unit as a physically separate structure. You just split the mortgage interest, property taxes and insurance between the two. Once all the rebuilding is done it's perfectly possible and highly likely that your cost bases for one unit (the burned up one) will be higher than the cost basis for the other unit. Nothing wrong with that.
So for 2023 you have one unit that was rented out starting at some time in 2023. Treat that as a physically separate unit. Once rebuilding is completed on the other unit you'll enter that as a physically separate rental property with it's own cost basis and start depreciating that one the day you make it available for rent.

[JadeDragon64]

Thank you very much for your quick reply! I always report the entire duplex as one rental property in the last 7 years. If I report them separately as two rentals this year (and possibly in the future years), do I enter two properties and put the purchase price, depreciation in the past, and cost of land as half-and half for each one of them?    

[Carl]

Yes. Assuming both were rented out and/or classified as a rental for the same time frame, you split it all, including the prior year's depreciation. But keep in mind that your restoration costs for the burned unit will be added as a physically separate asst for "that" unit, once all the work is done and it's available for rent again.

[JeanAtkinson]

Thanks @Carl, the doc and everything you wrote in this thread is super helpful!

As I see it, TurboTax is really quite weak in the way it handles this, because it does not know how to correlate losses to assets. So you end up having to re-enter everything and make them match.

Instead, in the loss section, it should let you just pick a schedule E asset, ask you for loss date and insurance payout, and manage the rest painlessly.

But with the right guidance, the more 'manual' way works, so thanks for that. 😀