February 9, 2022

With more and more natural disasters hitting the United States over the past few years, many individuals have experienced the loss of personal belongings and even more treasured items. Many people are fortunate enough to have their valuable collections (whether it be art, coins, baseball cards, etc.) covered by insurance; however, they need to consider the unintended tax consequences of how they spend their insurance proceeds.

Let’s take art as an example. Debra purchased art in 1968 for $200. When Debra discovers her art is worth $200,000 in 2013, she decides to purchase insurance on the piece. Unfortunately, the art is destroyed in a flood in 2021. Debra is fortunate she has insurance and ultimately receives an insurance payout of $200,000. But what should she do now?

What Debra Should Not Do

Debra always dreamed of owning and running an ice cream truck in her neighborhood, so she decides to invest the insurance proceeds into buying and licensing an ice cream truck. Unfortunately, she will be required to pay tax on the difference between the insurance proceeds she received and what she originally paid for the art since the replacement property was unrelated to the insured and lost property. Debra will feel the pain of loss a second time when she files her next tax return.

What Debra Should Do

Debra decides to replace her destroyed art with an original Monet valued at $210,000. Debra uses the $200,000 insurance proceeds and an additional $10,000 from her savings to purchase the piece from an unrelated seller in 2022. This would be ideal because Debra has replaced her destroyed art with qualified replacement property and therefore has deferred the capital gain on the art until it is subsequently sold.

What can you do to plan ahead?

Start by evaluating your collections and valuable assets that are uninsured. If you own valuable items and believe they are worth insuring, speak with an insurance provider. If the collection is ever lost or stolen, you will want to talk with a tax advisor before collecting the proceeds to ensure there are no unintended tax consequences. Need help crafting a plan to be prepared? Contact us today!

This information is general, not specific, and is only meant to give perspectives on matters discussed which may change without notice. It is not intended to be tax or financial advice.  Information has been obtained from various sources believed to be reliable, but interpretations and accuracy are not assured. Please contact us for any questions you may have or to revisit your planning strategies.