Your client, Piano Keys Inc., owns and operates a piano repair shop in Albany, New York. Piano Keys specializes in the repair and restoration of pianos.

In November of last year, the roof over two-thirds of the Piano Keys building collapsed due to the weight of the snow on the roof. Since then, the portion of the building damaged by the roof collapse has been demolished, an addition was built onto the undamaged portion (one-third) of the building, and Piano Keys reopened for business on September 1^st of this year. The following data includes financial information regarding the matter provided by the client.

• The fair market value of the building (immediately before the roof collapse): $1,800,000
• Piano Keys adjusted basis in the building: $300,000
• The fair market value of the building immediately after the roof collapse was $600,000.
• Insurance proceeds due to the destruction of his building: $1,200,000
• Demolition and construction costs: $1,500,000. ($1,200,000 of the insurance proceeds and an additional $300,000 of the companys own funds.)

Mrs. Jennifer Keys, the president of Piano Keys Inc., would like to know the federal income tax consequence of this matter.