Do You Need to Report Property Insurance Reimbursement on Your Tax Return?
We always strive to use our blog to inform and educate our clients about all things involving insurance.In the aftermath of a natural disaster, taxpayers are often confused about what they may or may not claim as a loss on their tax returns. One question I get asked a lot by clients is whether property insurance settlement proceeds and/or losses should be reported on a tax return.
Whether you must include property insurance settlement proceeds as income depends on the facts and circumstances of your case. Generally, if you’ve suffered from a theft, accident, fire, flood, hurricane, or some other casualty loss during the year, you may deduct a casualty loss on your federal income tax return.
What is Adjusted Basis?
As a general rule though, property insurance settlements for loss in value of your property that are less than the adjusted basis of your property are not taxable and generally do not need to be reported on your tax return. This means that as long as the proceeds from the settlement reimburses you for damage to your property, you do not need to pay taxes on the insurance proceeds. However, if the property settlement exceeds your adjusted basisin the property, the excess is considered income. You might be wondering what your adjusted basis in your property is. Adjusted basis is the cost of your property increased or decreased by various events, such as improvements and casualty losses. This means you receive more from the insurer than you initially spent on the item.
Example:if you purchased your home for $300,000 and you then receive a $400,000 settlement from your insurance company because the value of your home has increased, you potentially have $100,000 of taxable income, because this is the amount that exceeds your initial investment in the property. If your insurer does not cover your entire loss, you may still be able to deduct casualty losses for which your insurance company doesn’t reimburse you.Keep in mind that the IRS only allows taxpayers to deduct losses in excess of 10 percent of their gross income. To learn how to calculate adjusted basis, here’s a link to the 2018 Tax Guide for Individuals published by the IRS.
What is Casualty Loss?
A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is either sudden, unexpected, or unusual. Casualty losses are deductible during the tax year that the loss is sustained. This is generally the tax year that the loss occurred. A casualty loss can result from the damage, destruction, or loss of your property from any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake, or volcanic eruption. However, a casualty doesn’t include normal wear and tear or deterioration that occurs over time.
There are three types of casualty losses:
Federal Casualty Loss:A federally declared disaster is a disaster determined by the President of the United States as determined under the Stafford Act.
Disaster Loss:A disaster loss is a loss that is attributable to a federally declared disaster and that occurs in an area that is eligible for assistance pursuant to the Presidential declaration. The disaster loss must occur in a county eligible for public or individual assistance (or both). Tip: Disaster losses are not limited to individual personal-use property and may be claimed for individual business or income-producing property and by corporations, S corporations, and partnerships.
Qualified Disaster: A qualified disaster loss is an individual’s casualty or theft loss of personal use property that is attributable to a major disaster declared by the President under section 401 of the Stafford Act. Examples include: Hurricane Harvey, Hurricanes Irma and Maria, and the California wildfires.
What Do You Need to Report a Loss on Your Tax Return?
As with many other items that are potentially tax deductible, the IRS sets requirements that must be met before you can deduct a loss on your tax return. In order to claim a casualty loss deduction, you must be prepared to prove not only that you lost property in a casualty, but the amount of your loss. This requires knowing your basis in the property (discussed above) and the amount of reimbursement you received. You must prove all of the following:
- Your adjusted basis in the property
- Pre-loss value of the property
- Reduction in value of the property
- Lack or insufficiency of reimbursement
If any of these situations applies to you, speak to your accountant or financial advisor. They can help guide you in the right direction. As you can see, it’s a bit complicated in terms of what you can or cannot deduct relative to home insurance and related expenses. The best place for information is either from a tax professional or the IRS directly. In either event, don’t forget about the potential deductions related to your home insurance.
None of the information contained in this blog post is intended as legal advice or opinion relative to specific matters, facts, situations, or issues. Additional facts and information or future developments may affect the subjects addressed and no guarantee is given that the information provided in this blog post is correct, complete, and up-to-date. Additionally, any U.S. tax advice contained in this blog post is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Consult with an attorney before acting or relying upon any information contained in this blog post.
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