## Facts

- A taxpayer owned and used as a principal residence real property consisting of a dwelling and surrounding land.
- The dwelling was destroyed by a casualty, and the taxpayer received insurance proceeds attributable to the destroyed dwelling.
- Within the replacement period described in I.R.C. § 1033(a)(2)(B), the taxpayer sold the remaining land (or a portion of it), realizing additional gain.
- After the destruction and before sale or reconstruction, the taxpayer continued paying interest on debt secured by the residence property.
- The taxpayer either sold the land or reconstructed the dwelling and reoccupied it as a principal residence within a reasonable period after the casualty.

## Issues

1. Whether a sale of the remaining land within the § 1033 replacement period, after destruction of the dwelling, is treated as part of the same involuntary conversion of the principal residence for purposes of § 1033 gain deferral.
2. Whether the destroyed residence property is treated as a “principal residence” for purposes of § 1034 and therefore a “qualified residence” under § 163(h) during a reasonable period between destruction and the property’s sale or reconstruction and reoccupation, permitting a mortgage interest deduction.

## Decision

- The IRS concluded that the later sale of the land within the § 1033(a)(2)(B) period is treated as part of a single involuntary conversion of the principal residence that occurred on the date the dwelling was destroyed.
- The IRS concluded that, in that circumstance, § 1033 (not § 1034) governs deferral of gain from both the insurance proceeds and the land sale, if § 1033 replacement requirements are satisfied.
- The IRS concluded that the property is treated as a principal residence (and thus a qualified residence) during a reasonable interim period after destruction if the taxpayer sells the land or reconstructs and reoccupies the dwelling as a principal residence within a reasonable period.
- The IRS concluded that otherwise deductible mortgage interest on the destroyed residence may continue to be deducted during that reasonable interim period.

## Legal Principles

- A principal residence (dwelling and associated land) may be treated as a single property unit for federal tax purposes when determining consequences of casualty destruction and related dispositions.
- When a dwelling is destroyed and the remaining land is sold within the § 1033 replacement period, the destruction and land sale can be treated as one involuntary conversion for § 1033(a) purposes.
- If § 1033 applies because the disposition is tied to an involuntary conversion, gain deferral is determined under § 1033 rather than under the principal-residence rollover rules of § 1034 (as then in effect).
- A destroyed residence may remain a “principal residence” for a reasonable period after the casualty, allowing treatment as a “qualified residence” under § 163(h) and continued deductibility of qualified residence interest, provided the taxpayer sells or reconstructs and reoccupies within a reasonable period.
- “Reasonable period” is a facts-and-circumstances standard focused on the taxpayer’s timely disposition or restoration and reoccupancy following the casualty.

## Conclusion

Revenue Ruling 96-32 treats a casualty-destroyed principal residence and a subsequent, timely land sale as a single involuntary conversion under § 1033, allowing gain deferral if replacement conditions are met, and permits continued deduction of otherwise allowable mortgage interest during a reasonable period between destruction and sale or reconstruction and reoccupancy.


Rev. Rul. 96-32, 1996-1 C.B. 177 (1996)