Oscar’s rental home (AB of home, excluding land = $100,000 ; FMV of home, exclud

Question

Oscar’s rental home (AB of home, excluding land = $100,000 ; FMV of home, excluding land = $500,000 ) was completely destroyed in a fire . Oscar had the home insured for its FMV. As a result, Oscar received insurance proceeds of $500,000. Oscar then used $ 450 ,000 of the proceeds to build a replacement property . Oscar used the other $50,000 of proceeds to pay off his student loans.

23. What is Oscar’s recognized gain or loss if Oscar elects nonrecognition where possible?

Note: you should calculate realized gain/loss first, but the question asks only for recognized gain/loss.

Note: understand how Oscar could avoid recognizing any gain on receipt of the insurance proceeds

24.What is Oscar’s basis in the replacement property if Oscar elects nonrecognition where possible?

Explanation / Answer

23.

Gain to the Oscar is 500,000-450,000=50,000, and assumed depreciation charged till fire was 30,000 So his total gain was 80,000 Oscar obviously did not wish to engage in a realization event, but a realization event it was when he received $500,000 in cash for his lost house. Thus, Oscar realizes a $80,000 gain under § 1001 ($500,000 A/R less $420,000 A/B) in Year 1, which he must include in his Gross Income under § 61(a)(3)—unless he is eligible to make (and does makean election under §1033 to defer recognition of all or a portion of his realized gain Read §§ 1033(a)(2)(A) and (B) and (b)(2). If Oscar makes the election referred to in § 1033(a)(2)(A) in Year 1 (by submitting the proper form with his Year-1 tax return) and purchases property “similar or related in service or use” to his destroyed property which he has already purchased, he can avoid recognizing a portion of his $80,000 realized gain. How much can he avoid recognizing? Under § 1033(a)(2)(A), he must recognize his $80,000 realized gain “only to the extent that the amount realized upon such conversion … exceeds the cost of [the replacement] property.” Because Oscar’s “amount realized” was $500,000 (equal to the insurance proceeds), and the cost of his new house was $450,000, Oscar must recognize only $50,000 of his $80,000 realized gain in Year 1 if he properly makes a § 1033 election.

24.

The $30,000 of unrecognized gain is not forgiven, however, as § 1033(b)(2) requires Oscar to reduce his $450,000 cost basis in his new house by the $30,000 portion of his realized gain that is not recognized in Year 1. Thus, his new house’s basis of $420,000 ($450,000 cost basis less $30,000 of unrecognized gain) perfectly preserves the unrecognized gain. If he sold his new House for exactly $450,000 (what he paid for it), he would realize and recognize the $30,000 of realized

gain that was not recognized in Year 1.

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