Discussion:Casualty Loss/Insurance Reim/NOL

Wanted to get some feedback/confirmation of my thoughts -

FACTS: A new client has come to me file an amended 2004 tax return, due to incorrect reporting of basis on some stock sales. That however is not the issue creating my confusion. In 2003 taxpayer loses primary home in fire, in a presidentially declared disaster area (San Diego fires of Oct. 2003).

On original 2003 tax return, t/p claimed casualty loss from event, which in turn created a large NOL. This was due to the fact that by the end of 2003, insurance company had paid him about 30% of the total final payout. It appears he had not estimated what the future insurance payouts would be. T/P carried back the 2003 NOL to 2000, 2001, and 2002 (used up in 2002), and obtained refunds those years for taxes paid.

T/P sold the fire ravaged property, which had been his personal residence (basically just land left after the fire) in 2004. On schedule D, he reflected the sale of the home, reducing the basis of the property as reflected on schedule D by the both the insurance reimbursement received in 2003, and also additional insurance proceeds received in 2004. The selling price was more than the adjusted basis, thus a gain, however, he excluded this gain by claiming the section 121 exclusion for sale of primary home (he had the home more than two years).

QUESTION: The exclusion does not seem right to me. He has gotten the benefit of a NOL carryback due to the "loss" from the fire, as measured between his original cost basis less the 2003 insurance proceeds, and received the benefit of the refunds from NOL carryback to 2000, 2001, and 2002.

He gets more insurance reimbursement in 2004, but does not modify the NOL's. His prior preparer reduced the basis of the home sale by the 2003 AND 2004 insurance reimbursements, but because the resulting gain is less than $500,000 (MFJ return), no gain is was taxed. Is this where the "Tax Benefit" rules come into play? Seems to me he is getting a double tax benefit. Excluding the gain from sale, granted gain has been increased because of the insurance reimbursement, and also claming only a portion of the insurance proceeds on the 03' return, creating a NOL. Am I on the right track?