to the Editor: On Tax Cheating
by Ordinary Taxpayers” (Allen J. Rubenfield and Ganesh M.
Pandit, March 2007) gave good examples and I agree with the conclusions,
except for one. Situation 1, “Small Insurance Damage Claims,”
leaves the impression that failure to have car damage repaired within
two years might cause the full $497.17 insurance proceeds to be
taxable under section 1033. The complete answer is more complicated.
Treasury Regulations section 1.165-7(b)(1) defines a loss as the
lesser of adjusted basis or the difference in fair market value,
reduced by insurance recovery and salvage value. Alternately, section
1.165-7(a)(2)(ii) defines the loss as the cost of repairs, if repairs
are actually made. If the insurance reimbursement exceeds one of
these benchmarks, such excess may be taxable under section 1033.
says that a recipient of cash for auto damage must report it as
taxable income if they don’t get the car fixed.
I must have been asleep. My understanding is that, as long as
the cash received is less than or equal to the decrease in value
of the auto, then the cash received is tax free, but must be subtracted
from the cost basis of the car.
of the coauthors responds:
disagree with the letter writers or question the legitimacy of
what they say. What I was getting at could obviously have been
explained a little better, or perhaps the example could have been
If the vehicle
is a personal-use vehicle and you decide to keep the money as
opposed to having the vehicle repaired, how do you determine the
reduction in fair market value? Do you go on the Kelley Bluebook
website (www.kbb.com) and say your car was in great shape as opposed
to fair or poor shape? If you continue to use the vehicle as your
personal vehicle even with the damage, has there really been any
loss suffered? Do you obtain an appraisal, to determine what the
actual loss is? What about older vehicles? What if it is not the
insurance company that gives you the money, but the other driver
because he does not want his insurance rates to increase? What
about the money you pocketed? Is it really a replacement for your
loss, or are you enjoying it?
personal property, and you cannot take a loss on personal property;
therefore, personal property has a $0 loss basis. The gain basis
would seem to be whatever you sell your car for, whether the actual
Bluebook value or FMV is greater, less, or nothing at all. Because
there is no basis to reduce a loss against, anything you receive
would be taxable income, as I interpret both sections 61 and 1033.
the example is as correct as you want to picture it. The problem
with the tax law is exactly what you are seeing. It is open to
interpretation by whoever takes the time to go through it. None
of us understands it. Mine is one interpretation of the law based
simply on the pocketing of a few dollars.
J. Rubenfield, JD, CPA
Clark Atlanta University, Atlanta, Ga.
note: In the print edition of this article in the March issue,
two references to IRS Form 4684 on page 44 were inadvertently
transposed to read 4864. There is no IRS Form 4864. The editors
apologize for the error.
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