Insurance Proceeds vs Real Costs to Repair

[Bonny]

Hi Everyone,

My rental condo had a plumbing problem which resulted in an insurance claim. The adjuster was very generous and estimated the costs to repair at about $7400. After deducting our $1000 deductible USAA sent us a check for $6400. We've just complete the repair to my unit and the costs are coming in at less than $2000.

I know I can't claim the repairs since those have been effectively "reimbursed" by the insurance co. But do I have to claim the net proceeds of $4400?

Many thanks for your help!

[mwcpa]

The 4,400 is taxable income...

[Bonny]

Hi mwcpa and thanks for answering the question. I can't remember ever seeing a spot on the tax forms for insurance proceeds but then, I'm not a tax professional and it's never come up before. Where do I report the excess proceeds?

[rangerj]

It is reported as ordinary income from the rental property (Schedule E). Note I did not say "rent".

[mwcpa]

"Business and income-producing property.  Use Form 4684 to report your gains and losses You will also have to report the gains and losses on other forms as explained next."

"Property held more than 1 year. If your losses from business and income-producing property are more than gains from these types of property, combine your losses from business property (other than property used in performing services as an employee) with total gains from business and income-producing property. Report the net gain or loss as an ordinary gain or loss on Form 4797. If you are not otherwise required to file Form 4797, only enter the net gain or loss on your tax return on the line identified as from Form 4797. Next to that line, enter “Form 4684.” Individuals deduct any loss of in-come-producing property and property used in performing services as an employee on Schedule A (Form 1040). Partnerships and S corporations should see Form 4684 to find out where to report these gains and losses.

If losses from business and income-producing property are less than or equal to gains from these types of property, report the net amount on Form 4797. You may also have to report the gain on Schedule D depending on whether you have other transactions. Partnerships and S corporations should see Form 4684 to find out where to report these gains and losses.Depreciable property. If the damaged or stolen property was depreciable property held more than 1 year, you may have to treat all or part of the gain as ordinary income to the extent of depreciation allowed or allowable. You figure the ordinary income part of the gain in Part III of Form 4797. See Depreciation Recapture in chapter 3 of Publication 544 for more information about the recapture rule."

From IRS publication 547 (www.irs.gov/pub/irs-pdf/p547.pdf)

[Bonny]

So it looks like I need to report the income on my schedule E and file form 4797.

I didn't do that last year when I had a $2800 loss and $1800 insurance proceeds. I just reported a $1000 capital improvement. I don't recall getting a 1099 from the insurance company. Hmmm I hope this doesn't wind up being a problem.

[rangerj]

I DO NOT DISAGREE in any way with what MW has said. IF the "rental Condo" is residential rental property then it is subject to section 168 MACRS and the depreciable life is 27.5 years (unless the 40 year depreciation is elected as an alternative). It would be reasonable to assume that depreciation is in excess of $4400 and thus depreciation recapture (section 1250) would apply and thus categorize the gain on the transaction in question as ordinary income (gain) rather than "capital gain". The transaction is an "involuntary conversion" and is treated as an exchange, as in sale or exchange, and therefore the gain could be a long or short term capital gain, but for the depreciation recapture provisions (section 1250 for real property). So, if the gain is in excess of the depreciation claimed up to the date of the transaction then you need to determine if the gain is long term or short term. I made a few assumptions, such as that the depreciation was more than the gain, and should not have responded as I did without asking about the depreciable basis, use (residential v commercial), holding period, etc. I should know better that to make such assumptions and MW has politely pointed out why. Thank you MW. I added the above in order to aid in the explanation to what would otherwise appear to be a simple question. Also see U.S. Treasury Regulations section 1.1250-3(d).