Our weekend beach home was totally destroyed by hurricane Ike. The insurance paid more than we paid for it when we bought the house in 2001. Will we pay income tax on the difference?

The insurance on the contents paid after deducting depreciation. Can we dedcut this difference?

The IRS has established special rules that apply to gains realized on Homes in Disaster Areas, (that is where the insurance reimbursements are greater than the cost of the home).The rules apply to taxpayers whose main home was located in an area declared by the President of the United States to warrant federal assistance as the result of a disaster, and the home or any of its contents were damaged or destroyed due to the disaster.

1. No gain is recognized on any insurance proceeds received for unscheduled personal property that was part of the contents of the home.

2. Any other insurance proceeds a taxpayer receives for the home or its contents are treated as received for a single item of property, and any replacement property the taxpayer purchases that is similar or related in service or use to the home or its contents is treated as similar or related in service or use to that single item of property. Therefore, taxpayer may choose to recognize gain only to the extent the insurance proceeds treated as received for that single item of property exceed the cost of the replacement property.

3. If the taxpayer chooses to postpone any gain from the receipt of insurance or other reimbursement for their main home or any of its contents, the period in which you must purchase replacement property is extended until 4 years after the end of the first tax year in which any part of the gain is realized.

4. However, the 4-year period is extended to 5 years if the taxpayers main home or any of its contents were located in the Hurricane Katrina disaster area (which includes the states of Alabama, Florida, Louisiana, and Mississippi) and that property was converted after August 24, 2005, as a result of Hurricane Katrina, but only if substantially all of the use of the replacement property is in that disaster area.

Thus, in your specific situation you do not have to recognize an immediate capital gain on the insurance reimbursement. In fact, you can postpone any gain from the receipt of insurance reimbursement for your home with the period in which you must purchase replacement property being extended for 5 years.

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