Tax consequences on insurance payouts
Hello,
I am trying to figure out the tax consequences on insurance payouts as I'm thinking about having a more tightly secured portfolio.
Lets say that the house has adjusted cost basis of $200k. The options for insuring the properties are fair value approach or full replacement cost. The fair value you can insure for whatever you feel is fair value (let's just say $250k in this instance) and full replacement will cost $400k.
If the house completely burns down, under fair market value approach the tax consequences are pretty easily determined by taking difference in payout vs the cost basis as the gain. However I'm wondering under full replacement cost, how this works out. Let's say the house was fully rebuilt for $400k. Under this scenario am I:
1) taxed for the excess $200k ($400k - cost basis) as capital gain and my cost basis is now $400k.
2) taxed for the excess $200k ($400k - cost basis) as capital gain and my cost basis remains as $200k.
3) not taxed for capital gain and my cost basis remains at $200k.
if it's either 1 or 2 I would almost steer away from full replacement cost since that would mean I am paying for a phantom gain that I will never realize (I would assume the fmv will most likely still be around $250k even if it was fully rebuilt with $400k of cost/labor). Thank you in advance for your help!