USA Excess Insurance Reimbursement after rental property casualty

[Delbert]

How should the following situation be handled on an individual 2019 tax return?

A residential real estate rental property, purchased in 1998, was damaged by Hurricane Florence in 2018. The property is in a presidentially declared disaster area. A timely insurance claim was filed for the damage.

Soon after the storm, and in 2018, partial repairs (to stabilize the property) were made at a cost of $1,000.00. The $1,000.00 cost was entered on the 2018 tax return as an expense on Schedule E.

In 2019 additional repairs costing $3,000.00 were made. No further repairs are needed. Also in 2019 insurance reimbursement of $7,000.00 for the storm damage was received.

Adjusted basis of the building at the end of 2018 was $20,958.00. Depreciation for 2018 was $2,942.00

I have found conflicting guidance about this. Some guidance says that the excess insurance reimbursement ($7,000-$1,000-$3,000 = $3,000 reimbursement in excess of repair cost) should be reported as income in 2019. (Reported where?).

Other guidance (scroll about half way down in this link https://www.irs.gov/businesses/smal...s-casualty-loss-valuations-and-sections-165-i) says (a) there is no casualty loss, (b) there is no taxable income, and (c) the building’s basis should be reduced by the amount of the excess insurance reimbursement.

I would appreciate any comments or advice about which approach is correct, and where to enter the amounts in the 2019 return. Thanks in advance.

 

[Drmdcpa]

It is a reduction of basis.

 

[Delbert]

It is a reduction of basis.

Thank you. Can you give me any help about the mechanics of how actually do a basis reduction? Does the calculation show up anywhere in my 2019 return? Must any form be filed?

As you can probably tell, I am not a tax or accounting professional. I will be very grateful for any help you give me about how to do it.

 

[Drmdcpa]

There should be a portion of the basis that is allocated to land. Land is not subject to depreciation. So as to not mess with depreciation already in place, simply reduce the land basis.

This is not absolutely technically correct. To be absolutely technical correct, you would reduce both depreciable and non-depreciable bases in their proportionate shares.

But that would be much more difficult, and from the figures you gave, materiality seems to dictate it is not needed.

 

[Delbert]

There should be a portion of the basis that is allocated to land. Land is not subject to depreciation. So as to not mess with depreciation already in place, simply reduce the land basis.

This is not absolutely technically correct. To be absolutely technical correct, you would reduce both depreciable and non-depreciable bases in their proportionate shares.

But that would be much more difficult, and from the figures you gave, materiality seems to dictate it is not needed.

Thank you once again. I appreciate your patience (so far) with my questions. The figures I gave were only for the building, not including land value. I believe that does not change your answer.

If I do undertake to apply a basis reduction to the building how should I do it? I am thinking to reduce the purchase basis, keep the prior depreciation unchanged, and use the reduced purchase cost to calculate depreciation during the remaining life. (I would need to take care in all future filings to be sure to correctly show prior depreciation, i.e. make sure my software is not calculating prior depreciation from the reduced purchase cost.) Would this approach be acceptable to the IRS? And if so, are there any forms to file with my return in connection with the basis reduction?

As an off the wall idea, could I enter a new negative-valued asset to the list of assets for the property (with a purchase date same as original purchase date)? (This assumes my software would allow that and would calculate negative depreciation on the new asset; I have not tried it yet.)

Finally, I find it very irritating that the IRS guidance says to reduce the basis but does not give any guidance how to do so. I regret needing to belabor the issue.

Gratefully yours,

Delbert

 

[Delbert]

For those with interest in this topic, I did finally solve this. I became extremely annoying with the help desk of my tax software company until they helped me confirm the answer (which is found in IRS Publication 946, "How To Depreciate Property"). Per Pub. 946:

P946 Pages 35-36 say:
4. You must stop using the tables if you adjust the basis of the property for any reason other than:

a. Depreciation allowed or allowable, or
b. An addition or improvement to that property that is depreciated as a separate item of property.
Basis adjustments other than those made due to the items listed in (4) include an increase in basis for the recapture of a clean-fuel deduction or credit and a reduction in basis for a casualty loss....

Basis adjustment due to casualty loss. If you reduce the basis of your property because of a casualty, you can-not continue to use the percentage tables. For the year of the adjustment and the remaining recovery period, you must figure the depreciation yourself using the property's adjusted basis at the end of the year. See Figuring the Deduction Without Using the Tables, later.

Example. On October 26, 2017, Sandra Elm, a calendar year taxpayer, bought and placed in service in her business a new item of 7-year property. It cost $39,000 and she elected a section 179 deduction of $24,000. She also made an election under section 168(k)(10) to take a 50% special depreciation allowance of $7,500 [50% of $15,000 ($39,000 − $24,000)]. Her unadjusted basis after the section 179 deduction and special depreciation allow-ance was $7,500 ($15,000 − $7,500). She figured her MACRS depreciation deduction using the percentage ta-bles. For 2017, her MACRS depreciation deduction was $268.

In July 2018, the property was vandalized and Sandra had a deductible casualty loss of $3,000. She must adjust the property's basis for the casualty loss, so she can no longer use the percentage tables. Her adjusted basis at the end of 2018, before figuring her 2018 depreciation, is $4,232. She figures that amount by subtracting the 2017 MACRS depreciation of $268 and the casualty loss of $3,000 from the unadjusted basis of $7,500. She must now figure her depreciation for 2018 without using the percentage tables.
(The example is for 7-year property, but the method is clear.)

How to figure depreciation without using the tables is shown on P946 pages 38ff. Basically the reduced basis (depreciated basis at end of prior year, minus casualty cost) is straight line depreciated over the remaining life of the asset. The remaining life will not be a whole number (because of the mid-month convention rules); directions for the calculations are given in this part of P946.

 

[Kat Maple]

Hi Delbert

Thank you for circling back to the post and describing what actually happened. So many posts on this forum never do that and it is very helpful to see the final answer.

Kat