18.19 Defer Gain by Replacing Property

If your property is destroyed, damaged, stolen, or seized or condemned by a government authority, this is considered to be an involuntary conversion for tax purposes. If upon an involuntary conversion you receive insurance or other compensation that exceeds the adjusted basis of the property, you realize a gain that is taxable unless you may defer gain (18.20–18.24) or, in the case of a principal residence, you may exclude gain under the rules in Chapter 29.

Filing Tip

Involuntary Conversion of Personal Residence

Gain on the conversion of a principal residence may escape tax under the rules discussed in Chapter 29. If not, tax may be deferred under the involuntary conversion replacement rules.

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You may elect to postpone tax on the full gain provided you invest the proceeds in replacement property the cost of which is equal to or exceeds the net proceeds from the conversion. Buying a replacement from a related party generally qualifies only if your gains from involuntary conversions are $100,000 or less (18.23). Gain realized on a destroyed or condemned principal residence that exceeds the allowable exclusion under the rules in Chapter 29 may be postponed by reinvesting at least the conversion proceeds minus the excluded gain (18.20–18.24).

The replacement period (18.22) is two years for personal-use property; for business and investment property it is two or three years depending on the type of involuntary conversion; for a principal residence and its contents involuntarily converted due to a federally declared disaster (18.3) it is four years. The replacement period is extended from four years to five years if the involuntarily converted property was located in the Hurricane Katrina disaster area, Kansas disaster area, or Midwestern disaster area, provided that substantially all of the use of the replacement property is in the respective disaster area. If you find that you cannot buy a replacement by the end of the period, ask the IRS for an extension of time. See 18.22 for further replacement period details.

Basis in replacement property.

Your basis in the replacement property is its replacement cost, minus any postponed gain.