18.17 Excess Living Costs Paid by Insurance Are Not Taxable

Your insurance contract may reimburse you for excess living costs when a casualty or a threat of casualty forces you to vacate your house. The payment is tax free if these tests are met:

Whether you have a taxable or tax-free reimbursement is figured at the end of the period you were unable to use your residence. Thus, if the dislocation covers more than one taxable year, the taxable income, if any, will be reported in the taxable year in which the dislocation ended.

The tax-free amount includes only excess living costs paid by the insurance company. The excess is the difference between (1) the actual living expenses incurred during the time you could not use or occupy your house and (2) the normal living expenses that you would have incurred for yourself and members of your household during the period. Living expenses during the period may include the cost of renting suitable housing and extraordinary expenses for transportation, food, utilities, and miscellaneous services. The expenses must be incurred for items and services (such as laundry) needed to maintain your standard of living that you enjoyed before the loss and must be covered by the policy.

Where a lump-sum settlement does not identify the amount covering living expenses, an allocation is required to determine the tax-free portion. In the case of uncontested claims, the tax-free portion is that part of the settlement that bears the same ratio to total recovery as increased living expense bears to total loss and expense. If your claim is contested, you must show the amount reasonably allocable to increased living expenses consistent with the terms of the insurance contract, but not in excess of coverage limitations specified in the contract.

The exclusion from income does not cover insurance reimbursements for loss of rental income or for loss of or damage to real or personal property; such reimbursements for property damage reduce your casualty loss (18.16).

If your home is used for both residential and business purposes, the exclusion does not apply to insurance proceeds and expenses attributable to the nonresidential portion of the house. There is no exclusion for insurance recovered for expenses resulting from governmental condemnation or order unrelated to a casualty or threat of casualty.

The insurance reimbursement may cover part of your normal living expenses as well as the excess expenses due to the casualty. The part covering normal expenses is income; it does not reduce your casualty loss.

EXAMPLES

1. On March 1, your home was damaged by fire. While it was being repaired, you and your spouse lived at a motel for a month and ate meals at restaurants. Costs are $1,200 at the motel, $1,000 for meals, and $75 for laundry services. You make the required March payment of $790 on your home mortgage. Your customary $40 commuting expense is $20 less for the month because the motel is closer to your work. Your usual commuting expense is therefore treated as not being incurred to the extent of the $20 decrease. Furthermore, you do not incur your customary $700 food expense for meals at home, $75 for utilities, and $60 for laundry at home. Your insurance company pays you $1,700 for expenses. The tax-free exclusion for insurance payments is limited to $1,420, computed in the third column below. On Line 21 of Form 1040 (“Other income”) you must report as income $280 ($1,700 − $1,420).

2. Same facts as in Example 1 except that you rented the residence for $400 per month and the risk of loss was to the landlord. You did not pay the March rent. The excludable amount is $1,020 ($1,420 less $400 normal rent not incurred). You would have to report as income the excess of the insurance received over the $1,020 exclusion.

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