Do I need to claim an insurance payment for damages?

[DoninGA]

You do not claim damages or an insurance claim for your personal residence on a tax return, unless you are in a federally declared disaster area.

[Opus 17]

If receive a payment from an insurance company for damages, it is only taxable if it is for more than your cost basis.

Your cost basis is what you originally paid, plus the cost of permanent improvements, minus any depreciation you claimed for business use.

• For example, you bought a car for $20,000, it was totaled, and you received $15,000 present value as damages.  Not taxable.
• You bought a car for $20,000, it was totaled, and you received $25,000 in replacement cost coverage.  $5000 is taxable.
• You bought a car for $20,000, and used it in business and claimed $10,000 of depreciation.  It was totaled and you received $15,000 present value as damages.  Because your adjusted cost basis is reduced by depreciation, your basis is now $10,000, so $5000 is business income. 

[M-MTax]

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@Opus 17 wrote:

• You bought a car for $20,000, it was totaled, and you received $25,000 in replacement cost coverage.  $5000 is taxable.
• You bought a car for $20,000, and used it in business and claimed $10,000 of depreciation.  It was totaled and you received $15,000 present value as damages.  Because your adjusted cost basis is reduced by depreciation, your basis is now $10,000, so $5000 is business income. 

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Only thing is that if ALL of the insurance proceeds are used to buy replacement property, like a replacement for the car, then any gain could be deferred under Section 1033.

The replacement property must be of similar or like-kind, however.

[Opus 17]

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@M-MTax wrote:

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@Opus 17 wrote:

• You bought a car for $20,000, it was totaled, and you received $25,000 in replacement cost coverage.  $5000 is taxable.
• You bought a car for $20,000, and used it in business and claimed $10,000 of depreciation.  It was totaled and you received $15,000 present value as damages.  Because your adjusted cost basis is reduced by depreciation, your basis is now $10,000, so $5000 is business income. 

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Only thing is that if ALL of the insurance proceeds are used to buy replacement property, like a replacement for the car, then any gain could be deferred under Section 1033.

The replacement property must be of similar or like-kind, however.

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I believe that is only for business property.  And, for completeness sake, the rule is similar if your house is damaged and you repair it, but the insurance payment to make the repair is more than the original price.   The general rule is as above.  For edge cases, please give specifics. 

[M-MTax]

I'll just let you read the statute and regs and draw your own conclusion (hint: it does not apply solely to business property - in fact, it can even apply to a principal residence).

https://www.law.cornell.edu/uscode/text/26/1033

https://www.law.cornell.edu/cfr/text/26/1.1033(a)-1

NB: I believe you might possibly be confusing Section 1033 with Section 1031, the latter of which does require both the property relinquished and replaced to be business property or otherwise held for productive use (i.e., not personal property).

[M-MTax]

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@Opus 17 wrote:
 the rule is similar if your house is damaged and you repair it, but the insurance payment to make the repair is more than the original price.   The general rule is as above.  For edge cases, please give specifics. 

Yeah, sure, here's an example:

You bought your house 60 years ago for $100,000 and have been using it as your principal residence ever since. The house sustained severe damage from major hurricane force winds and, among other things, the roof needs to be replaced.  The house is now worth $10 million and the insurance company issues a check to you, in the amount of 700,000, to replace the roof, install new windows and doors, et al. You pay a contractor $700,000 to effect all of the repairs. The gain ($700,000 - $100,000) is NOT taxable to you immediately but can be deferred per Section 1033. 

I can tell you don't deal with these types of issues personally but just try to guess the correct answer or use logic to rationalize your answers and that doesn't work with the Code and Regs. You should be made aware that in the hypo I wrote above that it's possible for the homeowner to never even touch the money from the insurance company for the damage sustained. For example, if the house was refinanced and had an $8 million mortgage, the check from the insurance company would almost certainly be made payable to you AND the lender. In that case you can rest assured that the lender would not just hand the funds over to you on the chance that you would make the needed repairs. You're going to need a contract in place to make the repairs and the lender will release the funds to that contractor (most instances). Hence, the reason for the statute and regs; you never actually touch the insurance proceeds.