Question

On January 10, 2017, a fire destroyed a warehouse owned by NP Company. NP’s adjusted basis in the warehouse was $575,000. On March 12, 2017, NP received a $740,000 reimbursement from its insurance company. In each of the following cases:

1. Determine NP’s recognized gain on this property disposition. Assume that NP would elect to defer gain recognition when possible. NP’s board of directors decided not to replace the warehouse.
2. Determine NP’s recognized gain on this property disposition. Assume that NP would elect to defer gain recognition when possible. On January 2, 2019, NP paid $745,000 to acquire a warehouse to store its inventory.
3. Determine NP’s recognized gain on this property disposition. Assume that NP would elect to defer gain recognition when possible. On February 8, 2020, NP paid $745,000 to acquire a warehouse to store its inventory.

Answer 1

1. The computation of realized gain on this property disposition is shown below:-
Realized gain = Reimbursement of insurance - Adjusted basis
= $740,000 - $575,000
= $165,000
Here, reimbursement of insurance is greater than the receivable of insurance than the difference would be considered as a realized gain.
So, the realized gain is $165,000

In the case of an involuntary conversion, the recognized gain:
If the following three conditions are met, as per IRS rules, then the recoded benefit will be zero.
The taxpayer must reinvest in the assets which are used in the same way as that of the replacement asset.
The asset replacement should actually happen within two years after the benefit being realized.
The cost of the exchange should be equal to or greater than the value of the involuntary conversion realized.

2. Company C recognized the benefits on January 10, 2018, in the provided situation, and on January 2, 2019, it bought a new warehouse. The exchange date is within two years after the date of realization (January 10, 2018). The amount of reinvestment is $745,000, which is more than $165,000 in realized profit. Therefore, there will be no recognized advantage as the given case is satisfying the conditions above.
Therefore, there will be no recorded gain.

3. In the given scenario, on February 8, 2021, the property was exchanged. the exchange took place after the realized benefit date, which is January 10, 2018, after two taxable years. The realized gain would only be $165,000 as its acquisition of the new warehouse did not occur within two years of the date of realization gain.

Realized gain = Reimbursement of insurance - Adjusted basis
= $740,000 - $575,000
= $165,000
So, the realized gain is $165,000