Tax Law (Questions About Taxes)/Casualty Gain! Form 3684 necessary?
QUESTION: Here are my scenarios and questions. Iíve tried to be as detailed as possible
A major hail storm went through our area and damaged multiple rental property roofs (owned by corporation (1120) and partnership 1065).
- Most incidents have actually resulted in gain because insurance reimbursement was more than cost of repairs accomplished.
- most roofs were not componentized when placed on books thus no separate basis.
- don't know FMV before or after storm.
- Instructions for Form 4684 states "If the cost of the replacement property is less than the reimbursement received, you must recognize the gain to the extent the for the actual cost of the new roof .
- Pub 547 states " you must increase your basis the property by the amount you spend on repairs that restore the property to its pre-casualty condition."
Iím looking for the cleanest and simplest way to do these on the tax returns and on books. Is the use of Form 3684 absolutely necessary?
Question 1: For the properties that I have a gain (and no separate basis for old roof), can I post the insurance reimbursement(deposit) and cost of repair (check to roofer) to building expense and have a negative expense (income) for the year and leave the basis of whole property as it?
Question 2. What happens if I received insurance claim in one year but didn't pay roofer until following tax year? Can I do a postponement of gain without using a Form 3684 until the roof is done and paid for?
Question 3: For those properties where I had an out-of-pocket expense (the insurance deductible) and no separate basis for the old roof, can I use the deductible I paid as the basis for the new roof? or is it better or possible to claim deductible as casualty loss? If yes, then I would have to post to expense account and not to new asset account?
ANSWER: I don't want to be the bearer of bad news, but. . .
You are in business. You are in a business as a Corporation. There is no accommodations for not knowing. The IRS is not a very tolerant organization. They strive to wreck businesses and they use any justification. Your not knowing your basis, not tracking each property separately, and not handling improvements properly is more than enough for any IRS auditor to get giddy thinking about how easy it will be to destroy you. Add to that inaccurate record keeping and this could get real bad.
The Corporation that you have has given you some tremendous tax advantages. If that is disallowed, you'll have to pay back all those savings plus penalties and interest. It could be tens of thousands of dollars, or more depending on your successes in real estate.
If you have no proof of basis, then when you sell you would have nothing to write off against the sale price. You'd pay tax on all of it at your personal prevailing tax rate. Plus you'd have to recapture all of the depreciation that you took and pay taxes on that.
You need better skills if you are going to be in business.
---------- FOLLOW-UP ----------
QUESTION: I have a basis on each home. I am tracking them separtely very carefully. I keep very detailed records. The only thing I did not doo was componentize the roofs out separately when the homes were purchased because residential appraisers do not normally do that in this area of the country.
I am very cognizant of the importance of keeping good records.
I apologize profusely, I misread your question.
A roof has an expected life. 30, years, 40 years, etc. If the damage required the replace of the entire roof that would be an "improvement" to the property (enhancing the longevity and the "value" of the home in the market) and would be an adjustment to basis. But if only a portion of the roof had to be replaced, that would be a repair and would be expensable.
This is a huge tax event. Taking a deductions today, or have a slightly higher depreciable basis and at sale a possibly higher basis lowering the gain, slightly.
This is a confusing issue even for accountants. It is all about mindset. Many are deadset that any replacement, carpet, cabinets, etc. are improvements. Even if you are fixing something that makes it uninhabitable. One public discussion written discussion that I was involved in on this subject a group of accountants claimed that if you replace the carpet in a single room, they would handle that as an improvement (making the house nicer), allowing no deduction at the time and attributing the entire amount to capital improvements. When in reality you are merely maintaining it's rentability. If there is a huge water damage stain in the middle of the carpet it would be deemed unacceptable to the potential client. I won the discussion with some, but others were "of the same opinions still".
The life of the building is not the depreciation schedule. Buildings have a life expectancy. Most building codes require at least a 50 year life expectancy. Many building maintained in good repair have lasted centuries.
So what is your mindset. Did you "repair" something that would have shortened the life of the building, or did you make an improvement that would have reinvigorated it to last much longer?
When all is said and done, you need to justify your decision of how you put it on the books. I don't know the extent of the replacement, nor can I decide your comfort in justifying your decision.
If it as I imagine, that you replace one side of single peak roof, then you have done nothing other than corrected an excellerated decay of the property, a repair.