Is a lawsuit settlement taxable in this instance dealing with a real estate investment?

[RedBrick]

I bought a property several years ago with the intention to remodel and rent the house. Due to a multitude of reasons (e.g., shady contractors that I'm currently in the legal process to resolve), I was never able to finish the remodel and rent the unit. Unfortunately, the contractor offered the house as all in one package (one fee for the house and remodel). Since the majority of the work was not done, the house's value is far below what I paid. 

Let's say I paid all in 50k (shown on the settlement statement when I purchased the house/remodel), but I was only able to sell it for 10k (FMV based on the condition of the house at the time). If I am able to get 40k via a lawsuit settlement, would this be taxed? 

[AlanT · Accepted solution]

No, you would not be taxed.  

Your basis in the property you purchased would be $50,000.  The proceeds from the sale ($10,000) plus the settlement ($40,000) equals $50,000.  You gain would be $0.  Which means the settlement would not be taxable.