Question: Your client’s commercial rental property caught on fire and the client received a $950,000 insurance check to repair the damage. Since the market for commercial office buildings has decreased with the transition to remote employees, the client decided to not use the insurance proceeds to restore the building, pocketed the money and sold the building as is for $200,000. The fire, the insurance payment and the sale all occurred in the same tax year. The client assumes that the $950,000 insurance proceeds are a nontaxable windfall without reporting a casualty loss and that they only need to report the $200,000 received for the sale. Does the client have to include the $950,000 of insurance proceeds on their tax return as well as the sale of the property?

Answer: Yes, the client reports the fire casualty insurance proceeds received and reports the sale. When a taxpayer receives insurance proceeds without restoring the property or replacing it with similar property, a gain is recognized [Reg. §1.1231-1(e)].

Since the client sold the fire-destroyed rental as is and pocketed the insurance proceeds received for the fire damage without restoring the building, the transaction is reported as two separate transactions: a business casualty loss and the sale of business property.

For the business fire casualty loss, complete Form 4684, Casualties and Thefts, using the adjusted cost basis to determine gain/loss from the insurance proceeds. The results flow directly onto Form 4797, Sales of Business Property, and from there to Schedule D, Capital Gains and Losses.

To report the sale on Form 4797, use the adjusted cost basis again to determine the gain from the $200,000 received from the buyer.