Question

Wanda, a calendar year taxpayer, owned a building (adjusted basis of $250,000) in which she operated a bakery that was destroyed by fire in December 2018. She receives insurance proceeds of $290,000 for the building the following March. Wanda is considering two options regarding the investment of the insurance proceeds. First, she could purchase a local building (suitable for a bakery) that is for sale for $275,000. Second, she could buy a new home for $290,000 and go back to college and finish her degree.

a. To minimize her tax liability, which of these alternatives should Wanda choose?
Option 1 results in a recognized gain of $________ and Option 2 results in a recognized gain $ ______ Therefore, Wanda should select__________.

Fill in the blanks.

Answer 1

Option 1: She purchases a local building for $275,000

Insurance proceeds are $290,000

Adjusted basis is $250,000

Gain = $290,000 - $250,000 = $40,000

As per tax laws she is required to reinvest the insurnce proceeds or the extra amount shall be taxed:

If she buys local building for $275,000, she will be left with an extra sum of $15,000($290,000-$275,000)

Recognized gain= $40,000 + $15,000 =$65,000

Option 2:

Gain is same as above of $40,000

Also, she has invested the entire amount of insurance proceeds to buy a new home hence her realized gain will also be $40,000.

Option 1 results in a recognized gain of $ 65,000 and Option 2 results in a recognized gain $40,000 Therefore, Wanda should select Option 2, as tax liability will be low on lower taxable income