REVENUE RULE 95-22

1995-12 I.R.B. 4,

INVOLUNTARY CONVERSION OF PRINCIPAL RESIDENCE IN A PRESIDENTIALLY DECLARED DISASTER

February 28, 1995

Section 1033. - Involuntary Conversions, 26 C.F.R. 1.1033(a)-1: Involuntary conversion; nonrecognition of gain.

Involuntary conversion of principal residence in a Presidentially declared disaster. To defer recognition of gain under section 1033 of the Code, a taxpayer must reinvest insurance proceeds received upon the destruction of the taxpayer's principal residence and its separately scheduled contents as the result of a Presidentially declared disaster. The proceeds must be reinvested in replacement contents (or both). However, a taxpayer recognized no gain upon the receipt of insurance proceeds for unscheduled contents destroyed in such a disaster, regardless of the use to which the taxpayer puts those proceeds.

ISSUE

How must a taxpayer reinvest insurance proceeds, received upon the destruction of the taxpayer's principal residence and its contents as the result of a Presidentially declared disaster, in order to defer the recognition of gain under s 1033 of the Internal Revenue Code?

FACTS

In 1992, A's principal residence was destroyed in a Presidentially declared disaster, resulting in the complete loss of the structure and all its contents. The destroyed contents included furniture, appliances, clothing, and various other items of functional and decorative use. The taxpayer does not have records sufficient to establish the original cost basis of many of these items. These general household furnishings were not separately scheduled for insurance purposes.

The destroyed household contents also included jewelry and sterling silverware, each of which was separately scheduled for insurance purposes. At the time of the disaster, A had a tax basis of $250x in the residence, $5x in the jewelry, and $2x in the silverware.

Later that year, A's insurance carrier compensated A as follows: $35x for the loss of the unscheduled household contents; $7x for the loss of the jewelry; and $3x for the loss of the silverware. A also received $300x as compensation for the loss of the dwelling.

In 1993, A spent $300x to construct a new residence on the site of the destroyed home. A also spent $40x to purchase assorted home furnishings and clothing as replacements for those destroyed in the disaster, and $10x to purchase a painting for display in the new residence. A insured the replacement furnishings under a general homeowner's policy. The painting was separately scheduled for insurance purposes. A did not replace either the jewelry or the sterling silverware.

LAW AND ANALYSIS

Section 1033(a)(2) provides, in part, that if property (as a result of its destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof) is compulsorily or involuntarily converted into money, which in turn is used to purchase property similar or related in service or use to the converted property, gain will be recognized only to the extent that the amount realized upon the conversion exceeds the cost of the replacement property.

Section 1033(h)(1)(A)(i) provides generally that if the taxpayer's principal residence or any of its contents is compulsorily or involuntarily converted as a result of a Presidentially declared disaster, no gain shall be recognized by reason of the receipt of any insurance proceeds for personal property which was part of such contents and which was not scheduled for purposes of such insurance. Section 1033(h)(1)(A)(ii) provides that in the case of any insurance proceeds not described in s 1033(h)(1)(A)(i) for the taxpayer's principal residence or contents destroyed in a Presidentially declared disaster, the proceeds shall be treated as received for the conversion of a single item of property, and any property that is similar or related in service or use to the residence so converted (or contents thereof) shall be treated for purposes of s 1033(a)(2) as property similar or related in service or use to such single item of property. Section 1033(h) was enacted by s 13431 of the Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-66, and is effective for Presidentially declared disasters that are so declared after August 31, 1991.

Under the facts, A received $35x as insurance proceeds for the destruction of unscheduled household contents. Section 1033(h)(1)(A)(i) provides that a taxpayer will not recognize gain upon the receipt of insurance proceeds for unscheduled personal property. Accordingly, A recognizes no gain upon the receipt of the $35x, regardless of the use to which A puts this money.

A also received a total of $310x as compensation for the destruction of the residence ($300x) and its scheduled contents (the jewelry ($7x) and the silverware ($3x)). Section 1033(h)(1)(A)(ii) provides that tax deferral under s 1033(a)(2) applies to the extent that a taxpayer spends an amount equal to the insurance proceeds received upon the destruction of the residence and the separately scheduled contents (the "common pool of funds") for the acquisition of a new principal residence and/or new contents for the residence. A's common pool of funds for purposes of s 1033(h)(1)(A)(ii) was $310x ($300x + $7x + $3x).

Within the statutorily prescribed replacement period provided under s 1033(h)(1)(B), A spent $300x to replace the destroyed residence and $50x to furnish the new home ($40x for general furnishings and clothing and $10x for the painting). Because A spent $350x to purchase a replacement dwelling and contents, which is in excess of the $310x common pool of funds that A received, pursuant to s 1033(a)(2) A will not be required to recognize any gain upon the destruction of the residence and its contents.

HOLDINGS

(1) A taxpayer must reinvest insurance proceeds, received upon the destruction of the taxpayer's principal residence and its separately scheduled contents as the result of a Presidentially declared disaster, in a replacement residence, any type of replacement contents (whether separately scheduled or unscheduled), or both, in order to defer the recognition of gain under s 1033 of the Code.

(2) A taxpayer recognizes no gain upon the receipt of insurance proceeds for unscheduled contents destroyed in such a disaster, regardless of the use to which the taxpayer puts those proceeds.

DRAFTING INFORMATION

The principal author of this revenue ruling is James L. Atkinson of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Atkinson on (202) 622- 4950 (not a toll-free call).