Rev. Rul. 86-12

1986-1 C.B. 290, 1986-5 I.R.B. 32.

INVOLUNTARY CONVERSION; INSURANCE PROCEEDS; USE AND OCCUPANCY INSURANCE

CONTRACT

Published: February 3, 1986

Section 1033.-Involuntary Conversions, 26 CFR 1.1033(a)-2: Involuntary conversion into similar property, into money or into dissimilar property

  Involuntary conversion; insurance proceeds; use and occupancy insurance contract. The Service will look to the underwriting and actuarial criteria and any other information used in writing the insurance is designed to reimburse for a loss of profits and fixed charges. Rev. Rul. 73-477 amplified.

ISSUE

  Are the written terms of a contract, described as a 'use and occupancy insurance contract', the sole basis to determine whether insurance proceeds from the contract are proceeds from insurance against lost profits within the meaning of section 1.1033(a)-2(c)(8) of the Income Tax Regulations?

FACTS

  The taxpayer, a domestic corporation, purchased a business interruption insurance policy. The written terms of the contract provide for protection and reimbursement for loss of the use and occupancy of the taxpayer's building and machinery resulting from fire or other casualty. The contract provides for a fixed payment of 200x dollars per day. The written contract does not specify how the amount of this coverage or the premium for the policy was computed. However, the premium and coverage were arrived at by application of underwriting and actuarial criteria and were based exclusively on the profits and fixed charges experience of the taxpayer.

  In 1981 the building and machinery were destroyed by fire and the taxpayer was reimbursed under its policy. The taxpayer invested all of the proceeds, received from the insurance company for its loss, in the rebuilding of the building and in repurchasing machinery.

LAW AND ANALYSIS

  Section 1033 of the Internal Revenue Code provides, in general, for the nonrecognition of gain to the extent that the proceeds of an involuntary conversion of property are used to purchase qualified replacement property.

  Section 1.1033(a)-2(c)(8) of the regulations provides that the proceeds of a use and occupancy insurance contract, which by its terms insured against actual loss sustained of net profits in the business, are not proceeds of an involuntary conversion but are income in the same manner that the profits for which they are substituted would have been.

  In Rev. Rul. 73-477, 1973-2 C.B. 302, the Internal Revenue Service was asked to consider whether the proceeds from an insurance contract that provided for per diem payments of 35x dollars, whenever specified causes suspended business operations, were subject to the nonrecognition treatment under section 1033 of the Code. Rev. Rul. 73-477 holds that because the insurance contract permits reduction of coverage based on profits and fixed charges experience, the insurance is designed to reimburse the taxpayer for a loss of net profits and fixed charges. Thus, the insurance proceeds were treated as ordinary income and nonrecognition treatment under section 1033 was not available.

  The facts in the instant situation are similar to those in Rev. Rul. 73-477, except that it is necessary to go beyond the terms on the face of the use and occupancy contract to determine the precise nature of the contract. See Helvering v. Le Gierse, 312 U.S. 531 (1941), 1941-1 C.B. 430.

  Section 1.1033(a)-2(c)(8) of the regulations is not intended to limit determinations of the type of insurance provided by a use and occupancy insurance contract to an examination of only the terms on the face of the contract. Thus, the insurance contract in this situation is determined to include underwriting and actuarial criteria based on the profits and fixed charges experience of the taxpayer.

HOLDING

  Written terms of a contract, described as a use and occupancy insurance contract, are not the sole basis to determine whether insurance proceeds from the contract qualify as proceeds of an involuntary conversion under section

1033 of the Code. The Service will look to the underwriting and actuarial criteria and any other information used in writing the insurance to determine if the insurance is designed to reimburse for a loss of profits and fixed charges. Accordingly, under the policy described above, insurance proceeds will be ordinary income and nonrecognition treatment under section 1033 will not be available.

EFFECT ON OTHER DOCUMENT

  Rev. Rul. 73-477 is amplified.

Rev. Rul. 86-12, 1986-1 C.B. 290, 1986-5 I.R.B. 32.