Is Insurance Claim on Rental Property Taxable?

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No, landlord insurance claims proceeds on rental properties are NOT taxable.

Some coverages available on Rental Property could be taxable, such as Loss Of Income.

Property owners are allowed to make tax deductions for the insurance premiums of their rentals since the Internal Revenue Service (IRS) categorizes this as a necessary business expense when renting out such properties.

Landlords can subtract casualty losses from their federal income tax returns when their rental properties are affected. A casualty is considered as loss, damage, or destruction of property caused by an unexpected, unusual, or sudden event. However, this only becomes eligible if the loss happens as a result of a federally declared disaster.

The good news is that when a disaster happens, the IRS is willing to provide aid by extending the tax deadlines for rental property owners. You can even file for a casualty loss and acquire an immediate refund on the taxes you have paid years before.

A deductible casualty loss can be a result of different causes, such as:

Attacks caused by terroristsEarthquakesFiresFloodsGovernment-ordered relocation or demolition of an unsafe buildingLandslidesSonic boomsStorms, including tornadoes and hurricanesVandalismVolcanic eruptions

One thing these listed events all have in common is that they occur suddenly. Since suddenness is the key term associated with a casualty loss, any loss that occurs slowly or progressively is not eligible to be labeled as a casualty loss.

For instance, rental buildings that steadily deteriorate due to harsh weather conditions are not considered a deductible casualty loss.

With that said, here are the things you should know about the tax impact disasters have on your property rentals.

Tax Deadlines Are Extended in Areas Prone to Disasters

Tax deadlines are normally extended by the IRS for the victims when they are affected by a major disaster. One example is when the victims of the storms and tornadoes in Tennessee are given until August 2, 2021 to file their business tax returns.

The job of the IRS is to automatically identify taxpayers that are situated in disaster areas covered under the policy and apply the extension as needed. 

For you to benefit from an extended deadline, your rental property should be located in an area that has been federally declared to be disaster-prone.

Since the identification is automatic, you do not need to ask for a deadline extension from the IRS.

How Are Losses Deducted From Disasters?

When disaster happens, landlord insurance will always be the first line of defense in terms of financial reimbursement for property owners.

However, not all rental properties are covered for losses caused by natural disasters. In fact, coverage for some types of losses may not be even possible.

For instance, losses due to earthquakes, hurricanes, and floods may not be covered unless a supplemental policy was obtained by the property owner beforehand. Sometimes the landlord may still need to pay out of their own pocket for repairs or replacements on their rental property.

Fortunately, rental property owners are allowed to deduct even uninsured casualty losses to a certain extent.

Landlord Insurance After a Disaster

Rental property owners may file for a deduction on a casualty loss only to the point where the loss is not covered by landlord insurance. Losses that are fully covered are not eligible for deduction.

Unfortunately, property owners are unable to avoid this ruling by choosing not to file their insurance claims. That is why it is important to file an insurance claim promptly even if it results in an increase in premiums or a cancellation of their policy.

The property owner can file for a tax deduction if they received less insurance than what was expected. But if they receive more, the additional amount will be labeled as income for the year when it is received.

How Much Deduction Can I Expect From Casualty Loss?

The amount a landlord can deduct is dependent on whether their property was partially or completely destroyed.

This is how the deduction is calculated when the property ends up being completely destroyed:

Adjusted basis – salvage value – insurance proceeds = deductible loss

The adjusted basis is the original price for the property including the total value of its improvements but minus the deductions received for depreciation. The adjusted basis on rental properties, landscaping, and land improvements are determined separately.

You can find the adjusted basis from the depreciation schedules and/or tax returns filed for the rental property.

Meanwhile, the salvage value is the total amount of anything that remains after the property has been destroyed. This usually totals to nothing in cases where total destruction of the structure happens.

FactorDescriptionAdjusted basisOriginal price for the property including the total value of improvements minus the deductions received for depreciationSalvage valueThe total amount of remainsInsurance proceedsBenefit proceeds received from the landlord insurance

In scenarios where the rental property is only partially destroyed, the amount for casualty loss will be the lesser of the adjusted basis of the property or the decrease in its value due to the casualty, minus landlord insurance proceeds and salvage value.

You can hire an expert appraiser to determine the salvage as well as the reduction in the fair market value of your partially damaged building.

As an alternative, the cost for repairs or cleaning after a casualty can be together with the decrease in fair market value. However, this can only happen when these conditions are met:

The repairs are needed to bring the property back to its original condition.The cost for repairs is not excessive.The repairs have been physically applied.The repairs are only for the damage.Property value is not greater than the original value after repairs.

For every item that is damaged or destroyed, the landlord should calculate the amount of the casualty loss to their rental property separately. Again, this could include the building itself, landscaping, and other improvements besides the structure.

As for personal items within the rental, you do not necessarily have to separately deduct these things.

Conclusion

Insurance claim on a rental property is taxable and can be deducted if you, as the landlord, qualify. According to the IRS, insurance premiums for rentals are considered a necessary expense and are thus covered.At ALLCHOICE Insurance, we can provide you with the landlord insurance you need to stay protected. Contact us today to get a free quote!