Question

In December 2016, Edward, a cash basis taxpayer, paid $1,200 fire insurance for the calendar year 2017 on a building he held for rental income. Edward deducted the $1,200 insurance premiums on his 2016 tax return. He had $150,000 of taxable income that year. On June 30, 2017, he sold the building and, as a result, received a $500 refund on his fire insurance premiums. As a result:

a) Edward needs to amend his 2016 tax return.
b) Edward includes the $500 refund in his 2017 income.
c) The refund does not affect Edward's taxable income.
d) Edward can carry forward the refund to offset future income.

Answer 1

Edward must include the $500 insurance premium refund as income on his 2017 tax return because it is a recovery of an expense that was previously deducted, reducing his taxable income for the 2016 tax year.

Step-by-step explanation:

The situation described involves an understanding of the tax treatment of insurance premium refunds for a cash basis taxpayer. In the tax year 2016, Edward deducted $1,200 for fire insurance premiums for the following year on a rental property he owned. However, upon selling the property in 2017, Edward received a $500 refund for the portion of the insurance that no longer applied to him since he was no longer the owner. As a cash basis taxpayer, Edward must include the $500 refund in his 2017 taxable income since it is a recovery of an amount deducted in a previous year which reduced his taxable income. The correct tax treatment requires Edward to report the refund in the year it was received.

There is no need for Edward to amend his 2016 tax return as the deduction taken was permissible in that year when the expense was paid. The refund does not affect 2016 taxes but alters his 2017 tax calculations. Furthermore, Edward cannot carry forward the refund to offset any future income because it is specifically related to the 2016 tax year's expenditures and must be accounted for in the year the refund was received, following the tax principle of claiming income in the year it's realized.