Property damage – insurance payouts taxable?

In the aftermath of Hurricane Ophelia some business owners may have experienced damage to their business property.  Hopefully, those that did have adequate insurance cover to pay for the damage.

How is the insurance payout treated by tax law?

Under Capital Gains Tax (CGT) rules insurance compensation received in connection with property is of a “capital payment derived from an asset” and therefore subject to CGT (33% at time of writing).  Basically, the property is deemed to have been disposed (sold) and the insurance compensation is considered to be the proceeds.

Deferment of CGT

If you use the insurance proceeds to repair the property, then the CGT liability is effectively deferred until such time that the property is sold.  This is achieved by reducing the original cost of the property by the amount of the insurance proceeds when calculating the gain.

There are 3 scenarios where the relief can apply:

1. Property not wholly lost or destroyed

Provided the entire proceeds are used to repair the asset, the proceeds will not be treated as a disposal.  The cost of the asset will be reduced by the amount of the proceeds when calculating the gain on any future sale.

2. Property wholly lost or destroyed – all proceeds reinvested

Where the property is completely destroyed and and replaced using the proceeds of the insurance claim it is treated as being sold at no gain/no loss.

When calculating the gain on any future disposal of the new asset, the cost will be reduced by the difference between the cost of the original asset less the proceeds received.

3. Property lost or destroyed – proceeds partly reinvested

The amount used to replace the asset must exceed the gain, otherwise no relief applies.  The amount of the gain is reduced by the proceeds not reinvested.  The cost of the new property is reduced by the proceeds reinvested when calculating any future gain.

This a relief and is not automatically granted

It is important to note the relief is not automatically granted.  To avail of this treatment the relief must be actively claimed in a tax return.

It also highlights the importance of retaining documentation relating to properties beyond the statutory 6 years, and that the financial history is adequately recorded and maintained.

 

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