The statements made in these blog postings do not qualify as tax advice. These statements are general comments based on general questions. Your specific facts will impact the application of the law to your situation.
Insurance payouts for a disaster loss are complex. The tax laws covering the disbursement of insurance funds are also complex. However, the intention of the tax laws in these cases is to assist the taxpayer in returning to the position they held prior to the loss. The tax laws are designed to allow the taxpayer to use all the funds to restore their prior lifestyle without the government taking a cut.
There are instances where the taxpayer might pay tax on an insurance payout, but that is rare as long as the taxpayer follows the plan laid out in the law. (Read more about tax issues following a disaster here.)
The typical homeowner policy has three “buckets” out of which payments are made to compensate the policyholder for losses resulting from their loss due to the disaster. The three categories include structure, personal property and additional living expenses.
Payments for structure are usually the largest amount and have the most complexities. In addition to the basic coverage for the structure – the home – insurance will pay for additional sub-categories, other structures (physical improvements that are not part of the main structure, such as a detached garage and fences); trees and landscaping (usually a limit on the amount paid per tree and possibly a limit on the total amount of trees); debris removal; and law and ordinance (code upgrades). “Extended Coverage” is also available from some carriers; it provides additional coverage in large disaster situations and is usually sold in increments of 25% of the base coverage “A” amount.
Coverage for personal property covers losses that are not part of the real property and improvements. One way to think about the difference between structure and personal property coverage is to imagine your home without a roof. Now, turn it upside down. Whatever falls out is personal property and whatever remains is structure. Open all the drawers and closet doors in your imagination and take the dog out first. There is usually a limitation on coverage for some items that are difficult to prove such as jewelry, cash and some documents.
Each of these categories has its own tax reporting requirements. Differences in reporting exists for primary residence v. second home v. investment property v. commercial property.