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Insurance Proceeds and 1031 Exchange

I was asked about a situation where a $4 million property incurs $1 million in damages, covered by insurance. The property was in the process of being sold as a part of a 1031 transaction. The buyer wants to buy the property as is, and reduce the price by $1 million, which would cause the seller problems in the 1031.

As far as I'm aware, if the seller doesn't use his insurance proceeds but replaces the property within two years, the receipt of insurance proceeds isn't taxable. But more important, the insurance payout would normally just reduce the owner's basis, not be taxable unless the payout exceeded the property's basis.

The accountant for the seller is saying the insurance payout is definitely taxable in this situation. He is proposing that the seller agree to put the $1 million back into repairs of the property as a part of the sale transaction.

I don't see a problem with the accountant's approach, but is that really necessary? I wouldn't think so.

How wrong am I here?

Thanks.

Reply to
Stuart O. Bronstein
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This is how I believe it works.

  1. Assume the M settlement is equal to or less than the depreciated tax basis and it is not greater than the actual amount of damages. There is no tax consequence of the payment. Owner can use the funds to repair the property before selling it or not repair it and sell it at a much lower price.

  1. Assume the M is greater than the tax basis and is not greater than the actual loss. There is a taxable gain (the amount received in excess of basis) if the owner does not use the money to repair the property. The gain can be deferred if the owner obtains replacement property within the requisite time period. The gain reduces the basis of the new property. I believe this requires that an election be made on the tax return.

Reply to
Alan

Thanks, Alan. That's what I thought. The buyer wants to buy it as it for the $3 million amount, and then the seller wants to put the $1 million he gets from insurance into the next property. His accountant is telling him that he has to jump through some hoops to do that. But as far as I can tell, he can do what he plans to without any problem or need to recognize taxable income.

I just told him (assuming that the insurance money doesn't exceed actual damages and that the total is less than his basis) not to worry about it.

Reply to
Stuart O. Bronstein

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