Build Malibu Better: Are Fire Insurance Proceeds Taxable? Have I Been Attending Too Many Taxation Seminars?

Any or all of the information below may not be true, applicable or strategically desirable for your personal situation. It is essential that you discuss the following with a CPA and/or tax attorney who is knowledgeable about your personal situation and financial goals before acting on the raw information that follows: 

1. Your fire insurance company just offered you a lump sum to settle your fire insurance loss. Will the IRS consider any portion of the money as income?

Google says the IRS generally considers any insurance proceeds on a primary residence to be reimbursement and, as such, it is not taxable. 

2. Several people have been talking about an “involuntary conversion” as a result of losing a home in a presidentially declared emergency. Why should I care?

There is a provision in the tax code which allows a property owner who has lost a home in a presidentially declared emergency (like the Woolsey Fire) to do a 1033 exchange into another property of equal or greater value while deferring paying the capital gains tax on the accumulated appreciation greater than $250,000 for a single person, or $500,000 for a married couple. Because the sale was the result of an “involuntary conversion,” you can roll the accumulated capital gain into the new property and not pay taxes on it until the second property is sold. It seems you must buy the new property within four years of the involuntary conversion. Under code 121, you may additionally have the ability to take $250,000 or $500,000 tax-free, depending on your marital status, of the proceeds, if you have lived in the home at least two years out of the last five.

3. This is super complicated. How do I find out if this works for me?

Please consult your CPA or tax attorney to discuss what works for your situation.

4. We had been thinking of buying a home that is more appropriate for our current empty nest status but didn’t want to give up our Proposition 13 taxes based on our purchase 30 years ago.

Your property taxes will go up unless you are over 55 and buying a home in Los Angeles County or another county that will accept your historic tax base. The above is based on Proposition 60, which was passed in 1986, and Proposition 90, which was passed in 1988.

5. That raises several more questions that really require a tax attorney or CPA: If I get the insurance settlement on my free and clear home and then sell my newly vacant lot, which I have been carrying as my principal residence for the last 30 years, how much of the long-term capital gain can I realize before taxation kicks in? Can I buy a replacement home equal to or greater in value to the sales price of the land and transfer my old tax basis to the new property?

Assume I bank my insurance settlement, sell the vacant land and pay the capital gain taxes on the sale of the land. When, if ever, are taxes due on the insurance reimbursement that I put in the bank? Can the answer to question No. 1 above be correct?

The Malibu Times is the first newspaper in Malibu, serving the community since 1946.

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