What is Replacement Property
Replacement property is any property that is received in place of property that has been destroyed, lost or stolen. Replacement property can be personal or business property and can include real estate, equipment or even vehicles. Replacement property is often insured by a casualty-insurance carrier.
BREAKING DOWN Replacement Property
Replacement property can exceed the value of the property that was lost if the fair market value of the property has increased since it was insured against. When this happens, the taxpayer may experience a taxable responsibility on the difference between the increased value of the replacement property and the adjusted value of the property that was lost. Some exceptions to this exist to provide a deferral of the tax burden if certain conditions are met. The perceived gain can also be excluded when the difference applies to a taxpayer’s primary residence.
Although there may be an increase in the value of the replacement property, the property being replaced should always be like-kind, meaning that it should be as close as possible to being the same. This won’t always be possible as some property cannot be replicated exactly, and the cost of some materials may have fluctuated in such a way that there is a value added to their use. Also, in some instances the property being replaced may have been one of a kind. A family heirloom, for instance, can be replaced, but the inherent sentimental value cannot be duplicated. Certain monetary products like stocks and bonds may not be able to be like-kind upon their loss if those items are no longer in circulation or available for purchase. Likewise, original documentation cannot be directly duplicated, only recreated.
An Example of Replacement Property
For example, Brian Jones' home catches on fire. Because he carried all required insurance policies and riders, he will receive a replacement for the lost asset of his home. The replacement will be rebuilt according to the standards of which it was insured. The new home replaces the old home, and the values are similar enough that he does not incur any additional tax responsibility.
Now consider that Brian’s deceased wife’s wedding dress was ruined in the fire. While the dress was insured, and he will be able to recoup the estimated present-day value of the garment, he will not be able to replicate the emotional value of the dress.
Both items, the house and the dress, were replaced in accordance to the insurance policies that insured them, but neither were duplicated exactly.