Can you please help me determining the cost basis of my inherited house .
My aunt died in October 2010 due to an accidental fire at her personnel residence . Due to the fire the FMV of her personnel residence was severely reduced ( The adjusted cost basis on the day of her death was $800,000 and the FMV after damage was $300,000). After her death the personnel residence was transferred to the trust. The trust (of which I am the beneficiary) received insurance proceeds of app $ 500,000 and rebuild the house. The trust recently sold the residential house in July 2012 for $890,000.

Can you please advise me:
1. What will be my cost basis while calculating the gain on sale of residence? Normally the step up basis of inherited property is the FMV on the day of decedents death?
2. Are the insurance proceeds that were used to build the house tax free?

The insurance proceeds are tax-free.

You can use the FMV at "date of death" or "at the six month anniversary of the death", whichever is most advantageous.

The cost basis of the repaired house is the original FMV on date of death of $300K plus the cost of capital improvements made to the property after it was inherited - note that the these improvements may not have been precisely $500K received from insurance, depending on what repairs were actually done.