Dear Tax Talk,
My insurance settlement for sinkhole damage to my home is $200,000. To fix my home with steel pillars (costs) $56,000. I paid the balance owed on the mortgage. Is the remaining $144,000 taxable income?
-- Carlos
Dear Carlos,
Apparently the sinkhole didn't sink you. You were fortunate enough to pay off your mortgage, and you may also avoid paying tax. An insurance settlement isn't taxable unless you have a gain from it.
The gain is determined by comparing the proceeds to the cost of the property. Suppose your home cost you $150,000, your gain on the receipt of the insurance money is $50,000. If you use all the proceeds to fix your home (within a certain time period) you would have no gain or loss.
If you use less than the entire reimbursement, you have a reportable capital gain to the extent of the lesser of the unspent proceeds ($144,000) or the gain ($50,000). Using $150,000 as your cost, you would have $50,000 in reportable gain if you only spent the $56,000 to fix the property. The reportable gain may be deferred if the property destroyed was your main home that you lived in for two of the last five years.
If the cost of the property was $200,000, you would have no reportable gain even if you did not reinvest in the home.
The time period for reinvesting the proceeds in repairs is two years from the close of the tax year you had the gain. If you received the proceeds in 2009, your reinvestment must be complete by Dec. 31, 2011.
Because your options are many and depend on various factors, I suggest you consult a certified public accountant about your particular circumstances.
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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.
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