taxes

Are insurance settlements taxable?

George SaenzDear Tax Talk,
I received an insurance settlement for a car accident I was involved in. Am I supposed to report my settlement when filing my taxes?
-- Lisa

Dear Lisa,
For the most part, insurance settlements for property damage and physical injuries are not taxable income.

An insurance payment for property damage is considered compensation to restore your property to its prior condition before the accident. You would only have a taxable gain if the insurance payment exceeds your cost in the damaged property.

In the case of automobile damage, this rarely happens, because the car's value usually declines from the time you purchased it. The amount you receive is considered an adjustment to the cost of the property. Whether or not you restore the property does not affect whether you have a gain. For example, if your car cost you $20,000 and your accident damage was $5,000, the $5,000 insurance payment is used to reduce your cost in the car to $15,000, and you don't have any gain.

If you get a body shop to fix your car for less, the cost of the actual repairs is added back into the basis of the car. Continuing the example, if you fix the car for $3,500, there is no gain from the $1,500 you did not spend to restore the car, and the cost of the car in your hands is $18,500.

If you have depreciated the car for business purposes, you would need to allocate the settlement between business and personal. Depending on the amount of depreciation you have claimed, you may have a gain for business purposes, whereas you would have no gain on the personal portion.

Insurance settlements for physical injuries are not taxable. Any amount you may have deducted for medical expenses that were covered by the insurance settlement would be considered income as a recovery of previously deducted items to the extent you received a tax benefit.

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