Is Loss Proceeds From Homeowner's Insurance Considered Income?
Tax season is hard enough during normal years when nothing goes wrong, but if you suffered a loss to your home and had to file a claim with your insurance company, you have the additional challenge of figuring out how to list the proceeds on your tax form. When in doubt, consult a tax professional so you don't fun afoul of the law.
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Taxable Proceeds
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Insurance proceeds are always taxable, unless you receive a life insurance benefit. A homeowner's insurance settlement often involves large sums of money containing potential tax revenue for the government. This does not mean you must always pay taxes on the money you receive, but rather that you must consider it at tax time to determine if you owe taxes on it. It is not automatically tax free.
Profit or Loss
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Your insurance benefit may trigger a financial profit or a loss, and both affect your taxes. Your insurance company attempts to indemnify you after a loss -- it tries to restore you to the same financial position before the loss occurred. It doesn't always work out that way. For example, if your home completely burns down, your insurer will give you a settlement based on the value of the home. If you bought the home for $200,000 and made $15,000 of improvements on it, your total cost basis in the home equals $215,000. If you receive greater than that amount, you have a profit, but a smaller settlement gives you a loss.
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Tax Impact
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If your insurer gives you $230,000 to settle your claim on the home with a $215,000 cost basis, your net gain is $15,000. This amount, not the entire settlement, is taxable, though you list it as a capital gain, not as income. If, however, you receive only $200,000, you have a net loss of $15,000. The Internal Revenue Service permits you to list this amount as a loss on your return, thus reducing your tax burden. A tax professional can help you list the appropriate amounts on your return correctly.
Documentation
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The IRS recognizes that disasters resulting in total losses often result in "extraordinary damage" from which it can be difficult to recover. If your home is destroyed, you may not have appropriate documentation to support your cost basis and the dollar amounts you list on your return. In these cases, the IRS states that it "will consider documentation requirements satisfied by the best reasonably available information presented in good faith." In other words, use the information that is available to you, and the IRS will work with you as best as possible to process your return without causing more hardship than you already have.
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References
- Photo Credit Form 1040 Tax Forms image by Viola Joyner from Fotolia.com
