Q&A with the Pennsylvania Department of Revenue
What is the PIT treatment of gain/loss realized/recognized from an involuntary conversion resulting from a casualty or theft?
What is the PIT treatment of gain/loss realized/recognized from an involuntary conversion resulting from a casualty or theft? Chapter 12, p. 3 (Table 12-1) would appear to treat these gains/losses differently than other involuntary conversions.
For Pennsylvania personal income tax purposes, the gain or loss from an involuntary conversion of business property from casualty or theft must be recognized in the year the settlement with the insurance company occurs or the year the casualty or theft occurred and it became known that no recovery would occur. The personal income tax has no provisions corresponding to Internal Revenue Code §1033. Gain is recognized when property is compulsorily or involuntarily converted as a result of its destruction in whole or in part, theft, seizure, or requisition or condemnation into property or money.
There is no adjustment in basis in the new property for the basis in the old property for nonrecognition of gain. The old property must be shown as a sale, exchange or disposition of property for Pennsylvania personal income tax purposes. Although the gain or loss on the property must be reported, any business asset replaced with like property would have the gain or loss reported as business or rental income rather than the sale, exchange or disposition of property.
For example, a semi-truck and trailer owned by an independent trucking company operating as a partnership are involved in an accident and the truck and trailer are considered to be totaled by the insurance company. The trucking company must report the insurance proceeds received for each as the sales prices of the truck and trailer and the adjusted basis of each is used to determine if any gain or loss should be reported.
If the truck and trailer are replaced, the gains or losses are business income or loss. If either or both of the assets are not replaced, the gain or loss on the items not replaced is reported in the sale, exchange or disposition of property class of income.
Pennsylvania does not permit losses on involuntary conversions of personal assets or property. However, gains must be reported.
For example, a taxpayer owns several classic cars that were purchased for a total of $100,000 and which are currently worth $150,000 based upon an appraisal by an independent appraisal. The classic cars were stored in a facility that was destroyed by a tornado. Each individual car was only insured for 80% of its original cost because the owner had not updated his insurance policy for replacement value insurance on the vehicles. The insurance company only paid $80,000 because it was the policy in place at the time of the tornado.
As a result, the taxpayer has a $20,000 personal loss that is not allowed for Pennsylvania personal income tax purposes. However, if the taxpayer had updated his insurance policy for replacement value insurance and the insurance company paid the current market value of the vehicles of $150,000, the taxpayer would have had to report a $50,000 gain on PA Schedule D.