Tax Treatment of Insurance Reimbursements

Generally, the insurance settlements for real estate and personal property damage are not taxable. Even if your reimbursement exceeds the cost of replacement property, you do not need to include the difference in your income. Why is IRS so generous you say? The idea is that the amount the insurance company reimbursed you probably does not exceed your original cost for the items damaged so you don't have a gain. If you don't replace the items with the insurance money, it's up to you; the law looks at it as a sale of the items without a gain.

However, if as a result of the damage to your property you were displaced and received some money for living expenses and instead of spending that money, you bunked with your friends, you might owe the IRS some money. Section 123 of the Internal Revenue Code provides that additional living expenses reimbursed by an insurance company can be excluded from income. If you don't spend the additional money for living expenses, you'll be taxed on the amount.