Question

Milt’s building, which houses his retail sporting goods store, is destroyed by a flood. Sandra’s warehouse, which she is leasing to Milt to store the inventory of his business, also is destroyed in the same flood. Both Milt and Sandra receive insurance proceeds that result in a realized gain and they both intend to purchase replacement property within the required time period.

a. What type of replacement property must Milt find and why?

b. What type of replacement property must Sandra find and why?

Answer 1

If you receive an insurance payment or other reimbursement that is more than your adjusted basis in the destroyed, damaged, or stolen property, you have a gain from the casualty or theft. Your gain is figured as follows.

• The amount you receive, minus
• Your adjusted basis in the property at the time of the casualty or theft.

However, you can postpone your gain if you purchase a replacement property which is similar to the one of service in use.

However, you cannot postpone the gain from a casualty or theft if you buy the replacement property from a related person. Replacement property must be similar or related in service or use to the property it replaces.

If you are an owner-user, "similar or related in service or use" means that replacement property must function in the same way as the property it replaces. If you are an owner-investor, "similar or related in service or use" means that any replacement property must have a similar relationship of services or uses to you as the property it replaces. You decide this by determining all the following.

• Whether the properties are of similar service to you.
• The nature of the business risks connected with the properties.
• What the properties demand of you in the way of management, service, and relations to your tenants.

a) Milt must find a replacement property which function in the same way as the property it replaces, i.e. retail sporting goods store. This is because if he finds a replacement property which is not similar to the one which is operates, he cannot postpone his gain and has to pay the taxes.

b) Sandra must find a replacement property which function in the same way as the property it replaces, i.e. warehouse which is rented. This is because if she finds a replacement property which is not similar to the one which is operates, she cannot postpone his gain and has to pay the taxes.