Generally, insurance proceeds for this type of claim are not taxable. However, there may be a taxable gain if the insurance proceeds were in excess of the original cost of the property, which is likely the case since your parents purchased the property in 1992.
If there is a taxable gain, your father can claim the primary residence exemption. If your main home was damaged or destroyed, and you lived there for at least two of the five years prior to the insurance event, then you can exclude $250,000 in insurance gains ($500,000 if you file jointly). This rule is exactly the same as if you sold your primary residence.
Example: If you bought your home 20 years ago with an adjusted basis of $90,000 but the insurer cut you a check for the home's fair market value of $200,000, thanks to the primary residence exemption, you have no tax liability despite the $110,000 gain.
The following article address this issue: Are Homeowner's Insurance Loss Payouts Taxable? See the information under Involuntary Conversion Exclusions.
