Insurance reimbursement isn't usually taxable income. The IRS regards it as compensation for losses you've suffered -- a way to restore your property to its former condition. If you report a property loss on your tax return, however, your insurance reimbursement affects how big a loss you can deduct. In some circumstances, you do have to report reimbursement to the IRS.
You can claim a tax deduction for property loss if the cause was sudden and swift, unexpected, and not an everyday happening. The IRS includes car accidents, earthquakes, fires, floods, shipwrecks and storms in that list. If you claim the loss, which requires itemizing deductions, you have to adjust it for any insurance reimbursement. Suppose a fire damages your house for $14,000 and your insurer covers everything but your $5,000 deductible. You don't report the $9,000 check you received, but you can only write off $5,000.
Your base your deduction on either the loss in value from the damage or the adjusted basis of your property before the loss, whichever is less. Adjusted basis is the original sale price adjusted for various factors. If your property has grown in value since you bought it, your insurer's check may be worth more than the adjusted basis. In that case, the excess is taxable income. Use form 4684 and Schedule D to report your gains to the IRS.
If the property damage happens late in the year, you may not get your insurance check until next year. You report your loss in the year it happens, using your best estimate of what the insurer will pay. Come next year, if you get a smaller reimbursement than you estimated, you claim the difference as a loss on next year's taxes. If you get more than you expected, report the extra money as income for next year.
If your reimbursement is more than your adjusted basis, you don't always have to report income: If you spend it all restoring your property or buying a replacement, the gain isn't taxable. Any money left over after you buy the replacement, however, remains taxable income. You have to spend the reimbursement payment on the new property: If someone gives you money to replace your car and you spend the reimbursement on something else, all the gain is taxable.
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