Tax Tip Thursday

While all of you were dealing with tornados, the shutdown of our town, and all the cleanup, I was traipsing around the UK! I apologize for my absences.

I would like to sincerely thank our friends who looked after the damage to our house so we didn’t have to come back to a house full of water. We are very grateful!

We saw Eric Clapton at Royal Albert Hall, drove around the Emerald Isle of Ireland, stayed in some fantastic little places, and drove on the wrong side of the car on the wrong side of the road on the tiniest little roads I have ever had the pleasure of driving! Then back to the Royal Albert Hall for Jeff Beck (and the sadly inappropriate guest appearance of Johnny Depp), and then back home again.

As an aside, it was interesting talking to people in London and throughout Ireland to find out they are experiencing many of the same economic, employment, and financial issues that we are experiencing here in Canada. Out of control housing prices, concerns about how our kids will ever afford one, staff shortages, their version of CERB, and ever-increasing prices of the necessities in life. Not sure if it’s any comfort, but at least we are not alone.

Anyway, today we are talking about insurance and damages incurred from the tornado that rolled through. I hope you are all okay and that there wasn’t too much damage to your property or belongings.

Are Insurance Settlements Taxable?

I have already had many people reach out to me and ask about the impact of settlements and/or writing off their damages on next year’s taxes.

Let’s start with the easier one.

If your home was destroyed and you receive proceeds to replace it, you will be able to claim the principal residence exemption. Otherwise (if your home was NOT destroyed), any proceeds should be used to repair damages and that is the end of it. Be sure to have an accountant prepare your taxes, as this can get complicated! We are here to help.

For Businesses?

Now, if you have a business or rental property that was damaged and you have insurance, hopefully it will be covered. Beware of the tax implications of the settlement, though! If the property was destroyed it is called an involuntary disposition and the insurance proceeds are considered sale proceeds. If the proceeds exceed the property’s cost, a capital gain will result and that may mean taxes are payable. This could happen if a building is insured at its replacement cost, if that is greater than its original purchase price. The difference could make a significant gain, especially if the property has appreciated over a long time.

Where the property is replaced, generally you can elect to apply the “replacement property” provisions of the Income Tax Act. Tax owing can be deferred to the extent the insurance proceeds are reinvested if the following criteria are met:

• The disposal of the property was involuntary (e.g., destroyed in a tornado),
• The property is replaced within 24 months, and
• The replacement property is used for the same or similar business purpose.

As long as the policyholder spends the full insurance proceeds on replacing the destroyed property, they can apply any gains to reduce the cost. This means they do not have to pay taxes on the payout.

For you to benefit from these tax deferral opportunities, you must file a tax election for the CRA to approve. The last part of it is VERY important! You have heard the expression, “timing is everything.” In this case, that is particularly important and true! From a timing perspective, the date the property is deemed to have been involuntarily disposed of is not necessarily the day of the disaster. Instead, the date can be delayed to the earliest of a series of events/conditions, the most common of which are:

• The day you agreed to an insurance amount as the full compensation,
• The day on which your compensation is finally determined by a court or tribunal, or
• Two years following the day of the loss or destruction if no claim, suit appeal, or other proceeding is launched by that date.

These time frames are particularly important in considering when a replacement property is acquired so you have time to take advantage of the involuntary disposition and replacement property rules.

That Sounds Complicated

It is, unfortunately. It’s not so bad just for houses being replaced, but business property gets difficult very quickly. However, we are here to help! We can help you navigate the ins and outs of this process to make sure that you keep more of YOUR money in YOUR pocket once all the dust is settled. Call now or book an appointment today to get started.

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.