Handling post-disaster property casualties
Tips on how to defer or avoid taxation on natural-disaster insurance payments
I’ve received numerous calls in recent weeks from farms and ranches hit by wildfire, hurricane or the derecho windstorm.
Grain storage bins, barns, hog buildings, equipment and livestock are just some of the examples that sustained damage or destruction from those natural disasters. In Iowa alone, the powerful Aug. 10 derecho damaged over 10 million acres of crops, including 40% of the state’s corn and soybeans, according to the Farm Credit Administration.
Many of the questions I’ve received concern the tax implications of insurance proceeds paid on natural-disaster claims. In some cases, the insurance payments that people have received represent a gain on their damaged or destroyed property. That’s known as involuntary conversion—and that gain could be subject to taxation.
There are, however, ways to defer or even avoid those taxes. The rules for disaster loss and insurance can be complex, but, in general, keep these tips in mind:
• If your property is destroyed due to federally declared disaster, additional tax help may be available. Special rules make it easier to avoid gain on insurance payments you receive for your property damaged in the disaster. For a federally declared disaster, depending on the type of property, you have up to four or five years from the date of the casualty event (expanded from two years) to settle insurance claims, and rebuild or replace the damaged or destroyed property.
• If you use all of the insurance proceeds you’ve received from a casualty to purchase replacement property within a “required period,” the casualty gain won’t be taxed. The “required period” begins at the time of the casualty event and generally ends two years after the tax year in which you received the first payments resulting in a gain. However, the basis of the replacement property is reduced by the untaxed gain. So, the gain is deferred but not avoided.
Here’s an example: If you had a $20,000 casualty gain and used all of your insurance proceeds within the required period to buy replacement property for $100,000, your basis in the replacement property is only $80,000. Your replacement property must be “similar or related in service or use” to the property that was destroyed.
• Gain will be recognized to the extent the cost of the replacement property is less than the amount of the insurance proceeds. For example, say you have a $50,000 basis in a barn or other asset that was destroyed in a casualty and you receive $80,000 in insurance proceeds. The casualty gain is $30,000. Within the required period, you buy a replacement barn for $70,000. That’s $10,000 less than the insurance payment you received. In this case, you’ll have to include $10,000 of the $30,000 casualty gain in gross income—the amount of the insurance payment not spent on replacement property.
This may be new territory for many of you, so I recommend you reach out to a tax expert to help you create the most tax advantages for your unique situation.
Because wildfires and hurricanes remain a threat over the next few weeks, I encourage you to check out USDA’s Disaster Resource Center. This website provides information about specific disasters, emergencies and USDA assistance during disaster events.
Editor’s note: Maxson Irsik, a certified public accountant, advises owners of professionally managed agribusinesses and family-owned ranches on ways to achieve their goals. Whether an owner’s goal is to expand and grow the business, discover and leverage core competencies, or protect the current owners’ legacy through careful structuring and estate planning, Max applies his experience working on and running his own family’s farm to find innovative ways to make it a reality. Contact him at [email protected].
