Most workers’ incomes are subject to federal taxes: you may also think that the payments you receive from insurance as indemnification for damages or losses occurred to your properties fall into the same category, and you will have to declare them later, but that’s not the case.
In general, what you get from an insurance settlement is not considered taxable by the IRS. It is also good sense that if you already pay the insurance company to stay safe against risks of damage to your properties, you shouldn’t be further burdened by taxation while dealing with a life-threatening event, such as a natural disaster that has involved your home. The same refers to minor events, like burglaries, sky water infiltration, HVAC system impairment, and alike.
However, there is a major condition where you will be called to declare the insurance claim. That is the case when you are potentially profiting from it, aka when the amount you receive from the company exceeds the actual damage: this may happen if your current home value has increased since the time of purchase. So, it is possible that you win a claim where the insurer pays a sum greater than necessary to fix the issues.
When you are reimbursed for an event that is listed among the perils, be it wind, fire or humans provoked, that will be generally for the amount of your damage or loss. You will receive the right sum to repair damages or rebuy items if they were stolen, so of course, this is not taxable. How you are going to spend that money is not considered, providing that you are wise, and you use it for the original purpose. You are not gaining on this transaction in any way, then it is not subject to taxation.
So, the answer to the original question is: it depends on if the amount you receive from the insurer is greater than the actual damage extent to your house. An important concept to be understood here is: adjustment to the cost basis. This parameter is basically used for calculating tax liabilities that result from selling an asset, such as taxes on capital gains. Any home renovation or replacement will adjust up its cost basis; the underlying theory is that in case the home will be on sale, that cost represents a gain, therefore will be taxable.
Every asset you are insuring has its own cost, the one you paid for at the moment you bought it; you may need to report a gain if the amount of the check is more than your adjusted basis of the property. How do you calculate the adjusted cost? If, for instance, the purchase price of your home was $220,000, it went through a fire and the dining room has been remodeled for $15,000, then you have an adjusted value of $235,000. Now, let’s assume that you insured your home for $300,000 (which will be the amount reimbursed by the insurer), then you have $65,000 of taxable return.
In the event of a total loss, the fair amount of the compensation may not be easily calculated in the first place, because of the need to factor in eventual improvements that were made to the house after the time of purchase and of insurance policy start. In a nutshell, any excess will be taxable.
Another possibility is when the claim concerns an investment property: since its purpose is actually making gain from it, any reimbursements aimed to repair or rebuild this house and its contents must be timely spent, otherwise will be considered a taxable return.
So, whenever the amount of a claim goes beyond the value of the object (house, car, or person) which is insured, that surplus will be considered an income, thus there will be taxes on it. Claims for property damage, like a car that was in your garage, are also subject to the adjustment to cost basis. For other unscheduled properties, like clothes, valuables, furniture, and similar, which can be covered if damaged, there will be no taxes, since the calculation of settlement will be just fair.
According to the Internal Revenue Service (IRS), homeowners insurance installments are never tax-deductible, nor premiums are. This means that you can’t claim any return on funds that are due to your insurer and come directly from it. However, it will be possible to specify some out-of-your-pocket expenses that can be detracted from taxes, so that you have a substantial saving in the long run.
You can discharge from taxes damages and losses that, because of different reasons, aren’t fully reimbursed from the company, and that you will pay on your own, so whenever there is a lack toward your coverage. However, this is true if you are living in a declared federal disaster area, and you can claim toward the percentage amount, for instance, a hurricane deductible, which is right the portion of coverage that you are bound to spend as per the policy agreement. These contingencies are known as ‘casualty loss deductions’: the value of the loss must ideally first be estimated by an appraiser, who will help with figuring the exact amount you are eligible to claim for.
Let’s say you arranged with your insurer a windstorm deductible of 2%: if the loss occurs, and the home was insured for $200,000, you will be called to spend $4,000 while the insurance company the remainder $196,000. Those $4,000 are tax-deductible, of an amount that varies upon different factors, but that in some cases can be the whole sum. If the deductible is too low (in proportion to loss), it is likely to be only partially written off.
Other possible situations where you are eligible to deduct your expenses are:
-if you use your entire home or just a room for business-related activities, you may assign that space, quantified in square footage, for that specific purpose, so as to be excluded from your standard homeowner’s insurance. In fact, the underlying policy doesn’t offer coverage for houses where some business takes place, but only for living in;
-if you’re a living-in landlord and receive revenues from the rental of some rooms, your homeowner’s insurance on the space occupied by tenants becomes tax-deductible. The same would be if you owned more properties, but used entirely and exclusively for rental income: since there are business expenses, those can be tax-deductible.
As for personal properties losses, there is a formula to determine tax deductibility: assume that you were robbed off a jewel worth $20,000, but it is only covered for $5,000. So you have a $15,000 loss and might want to claim a deduction for it. Will you have any return?
Suppose that your annual gross income is $100,000, then your deduction will be the $15,000 loss minus $100 (as a rule) minus $10,000 (that is the 10 percent of your income):
$15,000- $100- 10% (income=$100,000)=$4,900 and this is your claimable amount.
Doing some research pays off at last.