If your home was destroyed in the fire and you must temporarily live somewhere else while your home is repaired or rebuilt, insurance payments for increased living expenses are excluded from income (i.e. not taxable).
This exclusion from income only applies to the excess of actual living expenses over the normal living expenses the taxpayer would have incurred during that period. (For these purposes, actual living expenses are defined as the reasonable and necessary expenses incurred because of the loss of use or occupancy of the principal residence to maintain the taxpayer and members of their household’s customary standard of living. Generally, expenses such as rent and utilities at the temporary residence, restaurant meals which normally would have been prepared at home and transportation expenses fall under this category). Insurance payments received for additional costs incurred in renting suitable housing and any extraordinary expenses for transportation, food, utilities and miscellaneous items are also excluded from income.
Payments received for the loss of rental income or reimbursements for damage or loss of real or personal property do not qualify for the income exclusion. If the taxpayer’s principal residence was used partially for business/rental, the portion of reimbursements attributable to the nonresidential use of temporary replacement property will be included in income.
Here is a rough summary of payments that are taxable vs. not taxable
Taxable Payments
- Normal Living Expenses
- Disaster unemployment assistance
- Expenses attributable to business use
- Loss of rental income
Not Taxable Payments
- Extra expenses for renting, transportation, food, utilities, misc services incurred while unable to use home because of casualty.
- Temporary increase in living expenses
Example 1 – Pat and Chris lost their home in the Tubbs fire. Before the fire, their monthly normal living expenses were $2,500 Mortgage/property taxes, $500 Utilities, $400 food = $3400 Normal Living expenses.
After the fire, their living expenses are $2500 Mortgage/property taxes (old house), $50 Utilities (old house), $2000 Rent (new temporary home), $250 Utilities (new home), $600 Food = $5400 Current Living expenses.
$5400 – $3400 = $2000 net increase in living expenses.
If insurance paid them $2000 then the reimbursement would be non taxable because it is equal to the net increase in living expenses (basically the rent for the new place).
If insurance paid them $2500, then $2000 would be non taxable and $500 would be taxable. They would still get their usual mortgage interest/property tax deductions which could help offset the additional taxable income.
See Treasury Regulation §1.123-1 for more information