Rental property insurance payment received.

[memememe]

We had hail damage to the entire outside of our rental. Had to replace our roof and all the siding. We received just over 30k from our insurance company, which paid the majority of the expenses. My concern is I think we need to claim this insurance as income? But if I do this, then I can only depreciate the roof and siding, and can't counter the full amount from the insurance company? By the way, the previous roof was only 3 years old, so we were still depreciating that one. How do I work that out? Do I take the remaining years of depreciation left on the first roof as a loss somehow, or something else?

[Carl]

Typically, all income received from any source for any reason, for rental property can be reported as rental income. It's reportable and potentially taxable as such, because all the insurance premiums you paid were a tax deductible business expense. However:

For an insurance payout you typically reduce your cost basis by the value of the loss, then increase the cost basis by the cost of the restoration. So it's possible for those two equations to zero each other out, resulting in no change.

Now, if the property was not habitable between the time the damage occurred and the time the repairs were completed, *and* your insurance payout included an amount for "loss of rent", that amount is definitely reportable as rental income, since the insurance company paid you rent for the period of time it was not habitable.

Now I'm sure you had a deductible which you had to pay. But, if the cost of repairs cost less than the insurance payout, then any excess insurance money would be reported as rental income.  While possible, I don't see that being your case, so will not discuss that any further.

Assuming the cost of restoring the property to it's condition prior to the event that damaged it does not cause a change in your cost basis (meaning the insurance covered the cost 100% with nothing out of your pocket) you really don't need to report anything concerning the event on your tax return, other than any "loss of rents" the insurance company paid.

However, if you did have to pay anything out of your pocket for the restoration, that would add to your cost basis of the property. You can just enter that amount as an asset and call it something like "new roof/siding" or whatever, classify it as residential rental real estate and start depreciating it over the next 27.5 years.

There would really be no need to report the insurance payout since the reduction in cost basis was offset by the restoration paid for by the insurance company.

Just keep in mind that any portion of the payout that is designated by the insurance company as payment for "loss of rents" is included in the total rental income received for the tax year regardless of what you may have actually used that money for.  Typically, insurance will pay up to 85% of the monthly rent you were receiving from the tenant before the event, for anywhere from 6 months to a full year. It just depends on the policy.

[memememe]

Thank you for your answer. We were lucky that our tenants were able to stay in the home.  I have one more question about the roof replacement.  We put on a new roof 3 years ago, and have been depreciating it.  But now with the roof replacement, do we start depreciating it anew, or just continue with the previous depreciation? Thank you in advance for your advise! 

[Carl]

With the "old" roof from 3 years ago,elect to edit/update that asset.

Write down the amount of cost for the asset, and the amount of "prior Deprec" already taken and continue.

Work through that asset and indicate that you "stopped using this asset in 2022". On the next screen enter the date it was no longer usable; i.e.; the date of the loss.

On the "Special Handling Required?" screen, read it to understand why I'm telling you to click YES. Then click YES on that screen.

Write down the "current year depreciation" on that roof asset.

Now add together the "prior Deprec" and the Depreciation Deduction Amount for 2022 to get the total depreciation taken on the roof.

Now subtract the total depreciation from the original "cost" of the roof.

This final total is what you can claim as a Miscellaneous Expense in the rental expenses section. It will allow you to claim a loss on the old roof for what is not already depreciated, since the roof was a total loss.

Next, you'll enter your new roof asset with an obvious in service date sometime in 2022 - typically the day after the work was completed.

So for 2022 you'll have two roof assets listed; the old roof and the new roof Next year, you can just delete the old roof asset if it gets imported.

There's another way to do this too. But to me, this seems to be the simplest to explain in a text based communications medium such as this forum.

[Cincolo]

How is the insurance payment handled if you receive it one year (2023) but don't replace the roof till the next (2024)?  Our accountant says it just goes under rental income, but it really isn't and will be used to replace the roof this year. I understand any excess over what we pay to replace it is taxable income, but isn't there some entry that should prevent it from being taxes as regular income?  There was no loss of rent .  Thank you!

[Vanessa A · Accepted solution]

You do not report this on your return. This would not be taxable income.  The payout from an insurance policy that you are paying for only becomes taxable income when it results in you being in a better financial situation than you started.  So, even if you didn't replace the roof, your roof had damage (currently in the amount the insurance company assesses it to be with the check they sent you).  So at this point, you have been made whole.  You do not have a gain in your overall asset/wealth.  So you would not report the payment on your taxes at all this year. 

If they paid you more than the roof was worth, then you would have a gain for the amount they "increased your wealth" and only that part would be taxable.  

[Cincolo]

Thank you!  To clarify, this is no different if the payment is received by an LLC, correct?  Do you happen to have an IRS document or other document I can refer her to to back up that it shouldn't be income?  If we enter the roof as an improvement in 2024 taxes, does there need to be something to offset the purchase?  I think our accountant is trying to make sure the insurance claim and payment are both accounted for, and that is what's causing the issue.

I've seen other posts with response similar to this one below (but to me, it makes more sense that it isn't taxable):  In reference to the insurance premiums being deductible expenses:  "Therefore, any payout on that policy is reportable income and may also be taxable. Typically, what the insurance pays out for is the loss of an asset that was being depreciated. The taxability of the payout can be offset by claiming the remaining depreciation of the asset that was lost, as a loss in the Casualty and Thefts section of the program under the Deductions & Credits tab.

For you, the first thing you have to do is figure the value of "just" the roof that was replaced, which would be a percentage of the entire value of only the structure.  Then the depreciation taken on the roof would be an equal percentage of the total depreciation already taken on the entire structure. Then you can claim a loss on that value only for the percentage of depreciation "not" already taken on that value."

[PatriciaV · Accepted solution]

The accounting treatment of the insurance reimbursement is different from how it's reported on your tax return. Once you have replaced the roof, you can determine if you have a reportable Tax Gain or Loss.  Until then, the insurance payment is not taxable income.

Here is the reference from IRS Pub 547 Insurance and Other Reimbursements

@Cincolo

[Cincolo]

Thanks for the clarification! The accountant is actually putting it under Rental Income on our taxes, and I can't understand why.  My sister is another LLC member and is speaking with the accountant regarding this--concerns me a bit that she thinks it should be entered there.  My sister is going to ask her to remove it.  We have other rental properties separate from the LLC properties, and we do our own taxes for those, so this is helpful to know.   

[Carl]

The accountant is actually putting it under Rental Income on our taxes, and I can't understand why.

Because he's doing this in what is probably the "best way" on the tax front, for the long term.

Typically, all income for rental property received from any source for any reason, is reportable as rental income. An insurance payout is reportable income. That's because the insurance premiums you paid were a tax detuctible rental expense. Therefore, the payout is reportable and in many cases, also taxable as such.
Now lets say you have $50,000 of damage to your rental property and it costs you $50K to fix it up and make it rentable again. Generally with that much damage it's not a "repair" per-se. For example, say a tornato takes the roof off and it's $50K for a new one. So the insurance pays out $50K for a new roof, and you spend every penny of it on that new roof.
The $50K payout is rental income. The $50K new roof is added as an asset and depreciated over the next 27.5 years.

So if you originally paid $100K for the property, with that new roof  your new cost basis in the property is now $150K. When you sell the property for say, $200K later down the road, you'll only be paying taxes on a $50K gain, plus any depreciation you're required to recapture.
So while the replaced roof may not increase the value of your property, then at a minimum it does "maintain" the current value. It also increases your cost basis in the property which matters big time when you sell the property.

[tagteam]

Insurance payouts to compensate the insured for property damage do NOT constitute rental income, @Carl 

[Carl]

Then you have to reduce your cost basis in the property by the value of the loss. You then increase the cost basis by the cost of the restoration. Not so easy to do with TurboTax.

[tagteam]

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@Carl wrote:

Then you have to reduce your cost basis in the property by the value of the loss. You then increase the cost basis by the cost of the restoration. Not so easy to do with TurboTax.

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TurboTax is not involved at all at this point. Read the posts by @PatriciaV and @Vanessa A