If you receive insurance reimbursement that is more than your adjusted basis in the destroyed or damaged property, you may actually have a gain as a result of the casualty or theft. However, the fact that a gain exists does not necessarily mean that it will be taxable right away. You will probably be able to defer the gain to a later year (or perhaps indefinitely) if you purchase qualified replacement property.
First, in calculating your gain, remember that you can subtract from your reimbursement any expenses you incurred in obtaining the reimbursement, such as the expenses of hiring an independent insurance adjuster.
Then, if you spend the same amount as the remainder of the insurance money you received, either repairing or restoring the property, or in purchasing replacement property, you can postpone tax on the gain. However, you must make the replacement within two years of the end of the tax year in which you have the gain. If the loss was to your main home, and the area was declared a federal disaster area, you have more time: up to four years after the end of your tax year in which you have the gain.
The replacement property must be similar or related in use to the property that was destroyed. For instance, if your car was destroyed, you can replace it with another car, but not with a piano. If your home was destroyed, you can replace it with another main residence such as a home or a condo, but not with a store building. If the property was investment real estate, then other investment real estate will qualify as a replacement, but not a second home. However, if the property was business or income-producing property located in a federally-declared disaster area, any business-use property will qualify.
You cannot postpone a casualty gain of more than $100,000 by purchasing replacement property from a related party, such as a corporation you control.
However, you can replace property and defer gain by purchasing a controlling interest in a corporation that owns similar property, as long as you own at least 80 percent of the stock.
If you purchase replacement property, you will have to reduce the tax basis of the new property to reflect the casualty gain you postponed.