Question Sec. 1033. In year one, Allen purchased a vacation home on a two-acre lot in Florida
for $100,000. In year three, Allen built an addition to the house at a cost of $50,000. In year five,
a hurricane destroyed the house, leaving a two-acre lot with a fair market value of $75,000.
(Immediately before the hurricane, the house had a fair market value of $250,000.) The president
of the United States designated the area struck by the hurricane a federal disaster area. In year
seven, Allen received $100,000 in insurance proceeds for the damage to the house. What are the
federal income tax consequences to Allen in year seven?
Answer Sec. 1033. Allen’s basis in the house is $150,000. In the absence of insurance his loss
would be $75,000 ($150,000-$75,000). After the receipt of the insurance proceeds, Allen has a
$25,000 gain ($100,000-$75,000). Because his entire loss is compensated by insurance, he is not
entitled to a §165 casualty loss. The gain is taxed unless converted into similar property. §1033.
Answer:
1) Deferral of recognition
2) Replacement of asset
3) Reinvestment of all the proceeds. Reinvestment of only part leaves taxpayer with an ability to pay
taxes.
4) Replacement asset’s basis is lower which defers the gain
5) Carryover of the tax attributes from the original asset to the replacement asset to reflect
continuation of the investment.