This article provides a brief overview of the income tax treatment of insurance proceeds for damaged or destroyed property, as well as a strategy grape growers can use to defer tax on their insurance recoveries.If a taxpayer’s insurance recovery for damaged or destroyed property is greater than the adjusted basis in the damaged or destroyed property, the taxpayer will have a taxable gain[2] and must report the gain as income in the year the taxpayer receives the reimbursement.[3] However, if the insurance recovery does indeed result in a gain, a taxpayer may be able to defer the gain (and avoid tax) under section 1033 of the Internal Revenue Code (I.R.C. §1033).Section 1033 mandates nonrecognition if property (e.g., the insurance proceeds) is used to purchase property “similar or related in service or use” to the converted property.

nvestors and professionals are quite familiar with the tax saving potential of a 1031 Exchange. Named after a section number of the tax code at 26 U.S.C. § 1031—which governs certain exchanges of one piece of property for another piece of property—a 1031 Exchange allows a property owner to defer capital gains by acquiring a like-kind replacement property and essentially rolling in the proceeds of the sale of the first property into the purchase of the second. To qualify, a potential replacement property must be identified within 45 days of the sale of the original property. And, once identified, the owner has 180 days to acquire title to the replacement property. Additionally, during the replacement purchasing phase, the funds from the original property’s sale must be handled by a qualified intermediary. The use of such an exchange can present significant tax efficiencies, if the tax payer can meet the stringent deadlines.In the world of eminent domain, a similar concept exists. Under 26 U.S.C. § 1033, the aptly named 1033 Exchange is similar to its 1031 sibling. Both allow a property owner to defer capital gains from the sale of real property by acquiring a replacement “like-kind” property. (For those of you wondering about the nonsequential numbering of 1031/1033 Exchanges—a 1032 Exchange is the exchange of stock for property.)However, the 1033 has some significant differences that are worth exploring. First and foremost, a 1033 Exchange is only available when property is “compulsorily or involuntarily converted.” 26 U.S.C. § 1033(a). Such a compulsory or involuntary conversion may be established when the property is acquired through the exercise of eminent domain through condemnation, or when there is the threat of condemnation or the imminence thereof. Thus, when the government files a suit in condemnation to acquire property, the just compensation award will certainly qualify for use in a 1033 Exchange. But, the filing of a suit is not required. Once the government has determi

d treat any remaining severance damages as gain. You can defer this gain under Code section 1033, under the same principles as in ”(2)(b)” and “(2)(c)” above. (Revenue Ruling 83-49 gives an example of how this calculation works.)(4)Can I keep my lower assessed value for California property tax purposes from the property I lost if I acquire replacement property??Generally yes, provided you apply to the assessor’s office of the county where your replacement property is located and the replacement property is “similar in size, utility, and function” to the property taken. “[S]imilar in size” for this purpose means that the value of the replacement property is no more than 1.2 times the value of the property taken. For more information see California Board of Equalization (“BOE”) Rule 462.500 and sample BOE Form 68 Claim for Base Year Value Transfer – Acquisition by Public Entity (each county will have its own form)One thing I did want to note about the matrix is the various references to Internal Revenue Code section 1033. Many of you are likely familiar with the phrase “1031 exchange.” IRS Code Section 1031 is a provision that property investors can utilize to defer tax on the sale of investment property by rolling the sale proceeds into a new investment property. Section 1033 is similar, but it applies specifically in the context of property being acquired by eminent domain or under threat of condemnation, and it includes some differences from Section 1031 that can be favorable to owners, including providing owners with more time to complete the transaction.Having said that, there are a few situations in which Section 1031 can be more advantageous than Section 1033, and a condemnee is always free to complete a “1031 exchange,” even in the context of a condemnation, if that is more favorable than a “1033 exchange.” Again, this is an area where consulting a qualified tax professional is crucially important, because one misstep can invalidate a 1031/1033 exchange with expensive tax consequences.Hopefull

It is not clear whether a watercolor is like kind to an acrylic, or whether a collage in a frame is like kind to a painting in a frame. In a somewhat related area dealing with involuntary conversions under IRC Section 1033, the IRS has taken a fairly narrow view. The standard under IRC Section 1033 is somewhat different than the like kind standard of IRC Section 1031.

[34] An involuntary conversion is property received compulsory or involuntary as a result of destruction, theft, seizure, condemnation, requisition, threat, or imminence. I.R.C. § 1033.[35] Treas. Reg.

[34] An involuntary conversion is property received compulsory or involuntary as a result of destruction, theft, seizure, condemnation, requisition, threat, or imminence. I.R.C. § 1033.[35] Treas. Reg. § 1.199A-2(c)(3)(ii). Any property or portion of a property received in an involuntary conversion transaction that exceeds the individual’s or RPE’s UBIA in the converted property is treated as separate qualified property that is placed in service on the date when the property was first placed in service by the individual or RPE receiving the property.[36] Treas. Reg. § 1.199A-2(c)(3)(v).[37] Treas. Reg. § 1.199A-2(a)(3)(ii).[38] Treas. Reg. § 1.199A-2(c)(3)(iv).

If the damage was to business or income property, different rules apply. If your investment property or property held for productive use in a trade or business is involuntarily converted due to "destruction, theft, seizure, requisition, or condemnation," and you receive cash or other property as compensation, that will be treated as property similar to the converted property under 26 U.S. Code § 1033. This means that you will either not recognize any gain, or will be able to defer recognition of a gain, depending on the circumstances.

The type of replacement property in a Section 1033 exchange depends upon the nature of the condemned property. Generally, the replacement property must be similar in service or use to the condemned property under I.R.C. §1033(a) (similar-use requirement). This is more restrictive than Section 1031's “like-kind” requirement, where all real property is like-kind to all real property.