Question

In: Economics

1. ABC Corporation owned a business warehouse that was destroyed by fire on October 1, 2020....

1. ABC Corporation owned a business warehouse that was destroyed by fire on October 1, 2020. On December 1, 2020 the corporation received an insurance payment of $900,000 for the loss. The corporation’s basis in the warehouse just prior to the loss was $500,000. The corporation would like to use the involuntary conversion rules to defer as much gain as possible. Assume the corporation built a new warehouse on the old site within the required timeframe and incurred construction costs of $950,000.

How much gain would be taxable?

What would be the corporation’s basis in the new building?

2. Assume the same facts as in (1) above except that the construction costs of the new warehouse totaled $875,000. Answer the same questions again.

How much gain would be taxable?

What would be the corporation’s basis in the new building?

Expert Solution

1) The corporation owned the building whose book value was $500000 when it was destroyed in the fire.
The corporation receives $900000 as the insurance claim and built the new building on the same site at a cost of $95000.

If the insurance claim received is more than the basis of the asset then the excess amount is subject to tax.
The taxable amount will be $400000

900000 - 500000 = 400000

However, if the cost of the new building is higher than the insurance claim received and the new building is constructed is the legally required time period then there will be no capital gains tax applicable here.

The basis of the new building will be adjusted by adding the excess amount required for the new construction.

500000 + (950000 - 900000)
= 500000 + 50000
= 550000

2) Now we have the scenario where the construction cost incurred is $875000.

The excess amount received in the insurance claim is $400000 which is taxable in normal circumstances.

However, the corporation has incurred $875000 for the new construction which is $375000 more than the book value of the destroyed building. The higher expenditure amount will reduce the taxable amount.

Taxable Amount
(900000 - 500000) - (875000 - 500000)
= 400000 - 375000
= 25000

$25000 will be taxable in this case.

Since the cost incurred for a new costruction is less than the amount of insurance claim so the basis would remain $500000 for the newly constructed buidling.

Rahul Sunny answered 1 year ago

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