Joe\'s expensive vacation home is destroyed by an electrical fire. The insurance

Question

Joe's expensive vacation home is destroyed by an electrical fire. The insurance company pays $600,000 for the structure. Joe's tax basis in the property is only $200,000 because he bought it many years ago. A. If Joe chooses not to replace the property, he will recognize a $600,000 involuntary conversion gain, B. If Joe elects to defer the gain but only spends $500,000 on the new property, he will recognize a $100,000 involuntary conversion gain C. If Joe makes the gain deferral election and spends exactly $600,000 to replace the vacation home within the required time period, he can defer $200,000 of the involuntary conversion gain, D. If Joe elects to deger the gain and spends $700,000 to replace the property, his basis in the replacement property is $200,000.

Explanation / Answer

Assuming that we have to select the best possible option feasible for joe:

According to my knowledge, option A or option B are best suited according to his requirements. I shall explain why prior to why not option C and D.

In option A and B, he gets an insurance claim of 600,000 in A which would be the current value or present market value of the house which is 400,000 more than the base price of the house. Similarly in B he gets the same value but in a different way as a gain of 100,000 as the 500,000 was used up to build/construct a new house. Hence, in both these cases, total compensation if for 600,000 which is 400,000 more than the basis of the property.

Whereas if we see option C and D, we get to know that due to deffered election gain, the insurance compensation would be equal to only 200,000 in both the cases even on spending 600,000 and 700,000 on the new structures respectively. Which in comparision to option A and B is less gains by 400,000 and 500,000 respectively over the basis of the property.

Hence it is smarter to select either A or B as they can also use that gains for their personal use, which otherwise in defered elected gain(which is already less in value) are bound to replace the same damaged property with another property in order to be elegible for the same late gains.

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