Tax question on repaired fire damage

[Shawn Ab]

Hi everyone,

I have a 4plex rental that sustained fire damage in 2020 and we received insurance proceeds to fix the damage (as the damage was 'medium' in that the rehab was pretty expensive, but did not destroy the property or render it unrepairable).  

My basic question is - how do I file taxes for this?  I perused some threads on here, and I see the points on tax basis, etc.. but wasn't exactly sure as for some people on here, it was their primary residence.

Quick overview - it's a 4plex in Houston, TX that I paid $212.5k to purchase in Oct 2017.  In Sep 2020, a fire happened (caused by electrical).  Long story short, the insurance company agreed to pay out damages, including ~$190k in estimated repairs and $7k in loss of rental income (and withheld $25k in depreciation).  How would I file taxes for this?

My calculation was --> (i) $215k purchase price - (ii) $22k depreciation from Oct 2017 to 2020 + (iii) $0 cost of improvements = $190k for the adjusted tax basis.  Then, (a) $190k in total rehab + (b) $7k loss of rent = $197k.  Then, (a)$197k of total proceeds - (b) $190k of adjusted tax basis = $7k of taxable gain.  Am I doing this right?  I wasn't sure whether cost of improvement would include the $190k rehab (effectively netting it out from the calculation).

[Michael Plaks]

@Shawn Ab

This is more complicated than you think. I can point you in the right direction, but I would not DIY it if I were you.

1. You start is correct: $190k adjusted basis. I will change it to $195k however, to be able to illustrate step 4 below.

2. You have a casualty loss of $190k in damages minus ($190k - $25k) in insurance compensation = $25k loss. I know this sounds like unnecessary steps, but you have to take these steps.

3. You have $7k extra rental income from the insurance compensation.

4. Your basis is now $195k - $190k = $5k. Sounds weird, but it is correct (and even fair if we really analyze the entire process)

5. You then spend $100k fixing the property. Your basis becomes $105k. The rest of insurance money is not taxed now, but it will end up taxed when you sell this property, which is the result of Step 4. 

You can also read this older thread for reinforcement: https://www.biggerpockets.com/...