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Rental Property Fire LossSo your rental property burned to the ground months ago and now it’s tax time. How to deal with it on the taxes is a common question, and one that can be answered and dealt with using the TurboTax program. Now there are several different fire scenarios, each dealt with in their own way. We’ll cover the three common scenarios here separately so you can pick the one that applies best to your situation and not get confused and frustrated. The three scenarios are:1) Total loss with insurance payout used to rebuild.2) Partial loss with insurance payout used to restore or rebuild.3) Total or partial loss with insurance payout not used to restore or rebuild.One thing that is common across all scenarios is the land. When dealing with Residential Rental Real Estate, insurance companies do not insure the land. They only insure the structure(s) on that land. So while a declaration of a total loss may be true from the insurance company’s point of view, it’s not a total loss for you. While the structure may be a pile of ashes, the land is still there and still has value. Total Loss with Insurance Payout Used to RebuildIn a nutshell, the depreciation you have already taken on the property has already been deducted. So you can’t claim it as a loss and deduct it again. That would be double-dipping and the IRS will catch it quickly and quite easily. However, the depreciation you haven’t taken is deductible as a loss. The question is, how? That will be discussed below. The insurance payout is another matter. Most get stuck trying to figure out how to deal with it on the SCH E. That’s not where you deal with this. It’s actually dealt with separately on the IRS Form 4684 which has nothing to do with the SCH E. You can also expect to have to pay taxes on a portion of the insurance payout too. That’s because the insurance most likely paid out more than what you initially paid for the property. Right off the top I suggest you put 20% of the insurance proceeds aside in anticipation of the tax liability that will be incurred on the payout. If your state also taxes personal income you’ll probably need to increase that percentage by a number equal to your state tax rate.Remember, when you first purchased that rental property, you did so with money you already paid taxes on. This will include borrowed money too, because the first thing you did with the insurance payout was to pay off the existing mortgage. Remember, the mortgage lender was listed as a lien holder on that property, and they got first dibs on the insurance payout for the loan balance due. So let’s lay out some basics to work with first. While the scenario is fictitious, we’ll be working with real-world actual numbers for accuracy with this scenario. - House purchased in May of 2010 for $100,000. Down payment was $20K and there is an $80K 30 year loan on the property with a fixed interest rate of 5.875%. Monthly payments are $472.75 - Set up the property in TurboTax 2010 and allocated $30,000 to the land. - Remaining $70,000 allocated to the structure to be depreciated over 27.5 years. - House burned down on Oct 17th, 2018 - Depreciation already taken in prior years up to Dec 31, 2017 is $19,196. - Depreciation taken on property up to the date of the fire is $2,015. - Total depreciation taken up to the date of the fire is $21,211. (This number is important!) - Insurance payout of $160,000 received on Dec 1, 2018. - Construction of new rental property scheduled to start sometime in 2019. Now that we have the numbers, let’s work this through the TurboTax program.Basically, you’ll start working through the property as if nothing happened. Enter your rental income received in 2018. This rental income will include what your tenant paid you for the period of occupancy, and will also include that portion of the insurance payout that was allocated by the insurance company for lost rent. Generally, the insurance company will pay up to 85% of your lost rent. So the insurance payout for lost rent must be included in the rental income. Some insurance companies include the lost rent as a part of the payout check. Other’s will include lost rent as a completely separate check. Either way, you can expect to receive a 1099-MISC from the insurance company reporting the amount of rent they paid in box 1 of that form. So determining how much of the payout is for rent shouldn’t be a problem. Next you will report your rental expenses. You can report all expenses incurred up to the date of the fire. Additionally, you can claim all expenses paid after the fire, so long as those expenses are directly related to the rental property. For example, if you paid to put your tenants up in a hotel or other accommodations while they found another place to live, you can claim that cost provided you can prove the cost is directly related to your rental. However, expect to be questioned if those expenses exceed 30 days. Paying to put your tenants up in a hotel for six months while you’re recovering and rebuilding is unrealistic and just not acceptable to the IRS. Your tenants should be able to find another place to live within 30 days after the fire quite easily. Now lets talk about the property the renter lost in the fire.Unless stated otherwise in your rental contract, you are not liable for the loss of any property owned by the tenant. Insurance companies do offer renter’s insurance. If your tentant didn’t have renters insurance, then they’re just out of luck. Even the most standard rental contract states that the owner/landlord is not liable for tenant losses in situations (such as a fire) the landlord/owner has no control of. But weather you’re liable or not, if you pay the tenant anything for their lost property, it’s flat out not deductible by you under any circumstances. But since you’re insurance policy includes up to $300,000 of liability, any liability payouts will be made directly to the tenant and you have nothing to report concerning such a payout. Let’s move on.The next item you deal with is rental Assets/Depreciation. This is where you’ll have to write some things down as you work it through, and keep the numbers for the math you’ll need to do later. Start working through the assets/depreciation section, and if prompted elect to go straight to the asset summary. Start with the actual rental property asset first by clicking the EDIT button next to it. You’ll need to write down the following information:Description, date (this is the date placed in service, not the date your purchased/acquired the property), Asset Type, Cost, Land, Prior Depreciation, Business Use percentage (which for this scenario is assumed to be 100%.) Now subtract “Cost of Land” from “Cost” and label that total “Cost of Structure”. Remember, you did not lose the land. So your real loss is only what you allocated/paid for the structure. In our scenario that loss is $70,000 and that will be what will be claimed later on the Form 4684. When asked if you stopped using the asset in the tax year, click Yes. The date acquired will already be filled in. For the date of sale or disposition enter the date of the fire.On the Special Handling Required screen, click Yes.The depreciation shown is for the period from Jan 1 of the tax year, up to the date of the fire is $2,015 using the numbers from this realistic scenario. Write this amount down. Then add it to the amount of Prior Depreciation you wrote down earlier. Label the total as “total depreciation taken” and write it down. You will need this figure later when you report the insurance payout on the Form 4684, and again after you rebuild and start renting the property again. In our scenario the total amount of depreciation taken on the property up to the date of the fire is $21,211. As stated earlier, this number is important and we will need it later. If you have other rental assets listed in the assets/depreciation section, you will need to work through each individual asset one at a time. Write down the same information as you did on the rental asset, indicate you stopped using the asset on the date of the fire, and when asked if special handling is required, answer yes. Further assuming you have other assets listed, you need to get the “real” totals of everything now. First, add up the cost of all assets, and remember that since you did not lose the land in the fire, you will not include the cost of any land in your equation. Next, add together the total depreciation already taken on all assets up to the date of the fire. When you have multiple rental assets listed that were lost in the fire, this total is the one you will use for the Form 4684 when it’s time. Once all the above is done, you’re basically done with the SCH E for this rental property. Next, let’s tackle the Form 4684 for Casualty and Theft losses. In the Deductions and Credits section (a tab on the Desktop version of the TurboTax program) there’s a heading for “Casualty & Thefts”. Elect to start/update this section and lets work it through. Each screen is explained below.For the event, lablel it something like “Rental Property Total Loss (Fire)” and enter the date of the fire. In our scenario, that date is 10/17/2018. Then select “income producing property” and that does it for this screen.Select Yes to indicate that the loss being claimed was passive income producing property. (Residential rental income is always passive.)For description of property, it’s best that it match exactly the description as shown on the SCH E. Then your acquisition date will be the date you originally purchased/acquired the property. It doesn’t matter if you have other assets that were acquired later (such as a new roof). Enter the date you originally purchased or acquired the property. For the cost basis this gets a bit tricky if you don’t pay attention to the details. Here you enter the value of the depreciable asset(s) only. You do not include the cost of the land since you did not lose the land. Additionally, you must subtract all prior depreciation taken also. So using the numbers in our fictitious scenario the amount entered here will be $48,789. Remember that total depreciation already taken that was written down earlier? It was in the amount of $21,211. So subtract that from our $70,000 cost basis of the structure that burned, and we get $48,789. That’s all we can claim as a loss on the Form 4684, since we deducted the $21,211 as depreciation over the last 8 years we rented the property prior to the fire. Since the insurance payout was $160,000 and I received a 1099-MISC reporting $6000 in box 1 for lost rent, I will subtract that amount from the payout and will enter $154,000 for the insurance payout. (We’ve already reported the lost rent amount in the rental income received, remember.)Now the fair market value (FMV) of the structure (not the land) the day before the loss was $155,000. The day after the loss the FMV was $0. This is assuming that if I were to have sold the building and other depreciable assets the day before the fire, the fair price I could have received for them was $155,000. That number has nothing to do with the amount of the insurance payout. However, note that with our scenario I’m taking into account the $1000 insurance deductible. But generally, what insurance pays and the FMV of the property will be so close, that they might as well be the same. Next you indicate that you used the property in your business or as rental property, and move on.When you get to a screen asking if you want to defer paying taxes on any gains realized from the insurance payout, select no. Overall it’s a waste of time because you can’t defer taxes on your gains in this situation. Basically with the insurance payout, you sold your property (the structure only) to the insurance company. Since the payout was more than your original cost basis on the structure and any other depreciable assets, you have a taxable gain on this “sale”. Yes, your taxes will increase significantly. Depending on the difference between the insurance payout and your adjusted cost basis after taking depreciation into consideration, I would not be surprised if your tax liability increased by several thousand dollars. Hopefully you put at least 20% of the payout aside to help cover that additional tax liability you incurred. In fact, 20% should be more than enough. But I wouldn’t go any lower than that. Otherwise you may find yourself in a financial bind when tax time rolls around. Especially if your state taxes personal income too. Of course, this begs the question of why the insurance proceeds in excess of your cost basis is taxable in the first place. Let’s take a moment to answer that question.In all the years you’ve been renting out the property, you got to deduct the property insurance from your taxable income as a rental expense. Therefore any gains realized from that deducible expense is taxable. It’s as if those insurance proceeds were invested into a bet or a wager that you would win…. and you did win in a way, at quite a significant gain. On the other side of that coin, the property insurance you paid for your primary residence where you live was not deductible. The insurance you pay for the car you own is also not deductible. You pay taxes on that money before you give it to the insurance company. In this situation where the insurance paid is not deductible, you are considered to be paying for a product. So when you have a claim on your residence or car that pays out, you don’t have to report a penny of it anywhere on your tax return. The insurance money you received is the “product” you paid for with after-tax dollars. Whereas on the rental property you paid for that “product” with before tax dollars. So that’s why the insurance payout on the rental property that exceeds your cost basis after depreciation is taxable income. Now let’s move on to the property rebuild and producing rental income again.At this point, if you have no intention of rebuilding then you are “almost” totally done on the tax front. But what about all that depreciation you did not and could not take after the fire? How do you get to deduct that? Simpler than you think.In our scenario the structure that burned had a cost basis of $70,000 of which we have already taken $21,211 in depreciation on. There’s still the remaining $48,789 of loss we haven’t deducted yet. But we still have and own the land which has a cost basis of $30,000 and the land was never depreciated because land isn’t depreciable. So we simply add the depreciation not taken to the value of the land. That gives us an adjusted cost basis of the land of $78,789. Therefore, if we choose not to rebuild and sell the land for exactly $78,789 we have no taxable gain. Now lets assume we’re going to rebuild a new structure on the land and start renting it out again.Chances are, you will not have the new structure move in ready before the end of the tax year in which the structure burned down and you got the insurance payout. But even if you do manage this before the end of the tax year, the procedures are still the same. We’re going to go with the assumption that your newly build structure isn’t move in ready and “in service” until the next tax year. So when you use TurboTax and import from the previous year, all that previous year rental data from your burned structure will be imported into the current tax year. Before we get started let’s talk about the cost of the rebuild.Using our scenario, with the payout of $154,000 for the loss of the structure the mortgage on that structure got paid off first. Using our figures, you put 20% aside for taxes. That’s $32,000. Then the old mortgage payoff amount was $69,300 leaving $52.700 cash on the barrel head to play with. Now in reality this amount may be a few thousand more or less, depending on the actual taxes paid on our insurance payout gain from the $32,000 we put aside just for that anticipated tax liability. The average cost to build a 3 bedroom 2 bath house with a 2 car garage is $170,000. So that’s the figure we’re going to use as our cost for rebuilding. On Jan 15th we secured our construction loan of $170,000. Rebuilding was completed and the property was move in ready and “in service” on Jun 1. The week prior to that we converted out construction loan to a standard mortgage at 5.875% over 30 years and put $40,000 down. That means we start with a $130,000 mortgage and still have a bit more than $12,000 cash on hand for those “incidentals” associated with our rebuilding and re-renting endeavor. Starting in the Rental & Royalty Income (SCH E) section of the program elect to start/update that rental property. You’ll report your rental income from the newly built structure, and then report all your rental expenses incurred from the time the newly built structure was placed in service and was “available for rent”. In the assets/depreciation section you see all the assets listed which were reported already as lost and no longer in service. All you need to do at this point is click the “Add an Asset” button and enter the property itself. It’s fairly straight forward. But lets walk through all the numbers one at a time.First, you’ll indicate that this a Rental Real Estate Property. Then select Residential Rental Real Estate. First enter your description. I usually use the house number and street name for this. But you can call it anything you want, such as “new structure” if you like. Next, enter the “Cost of Land” amount. Remember how I mentioned that increase in the cost of the land earlier? It still applies here. Take the amount of depreciation you did not take on the lost structure, which in our scenario is $48.789 and add it to the original $30,000 cost of land. So for this new asset the cost of land will be $78,789.Now for the “cost” box, add the cost of the land to what we paid for the new building, which was $170,000. That gives a total cost of $248,789. The date purchased or acquired will be the date you converted the construction loan to a standard mortgage. Now indicate that you purchased the asset new, and that it’s been used 100% of the time for business. For the date you started using it in this business, enter the date that a renter “could” have moved in. Then press on. That does it.Depreciation on your newly constructed building starts on the “in service” date you entered, and it starts all over from year 1. So it’s going take the next 27.5 years to fully depreciate the $170,000 you paid for the new contruction.Now, if all this happens in the same tax year, you’re done and can now move on with the program and leave the Rental & Royalty Income (SCH E) section of the program.If you reported your loss in a previous year, and this year you are reporting the new construction, then you can go ahead and delete all the other assets from the Your Property Assets screen, and leave only your new asset entry you just made. You’re done. I’ll be covering the scenario for partial loss with insurance payout used to restore or rebuild in another document at another time. ................
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