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In the past, the President declared parts of our country a disaster area eligible for federal assistance.  While I hope that you have not been a victim, you should be aware that if you suffered property damage as a result of the disaster, you may be eligible for the following types of tax relief.

Choice of when to claim losses.

If you suffered a casualty loss as a result of the disaster, you may be able to recoup a portion of that loss through a tax deduction. Moreover, you have a choice of which year to claim the loss.

Losses from Presidentially declared disasters can be deducted either in the tax year in which the loss occurs or in the immediately preceding year. This option may increase the tax savings from the loss and may enable you to obtain a refund from the Internal Revenue Service before you even file your tax return for the year in which the loss occurred.  For example, a loss that occurs this year can be claimed on this year’s return, which will not be filed until early next year. But if you elect to claim the loss last year (by claiming it either on your original return or an amended return), you can generally expect to receive the refund within a matter of weeks. This can help to pay some of the repair costs. To claim the disaster loss on your return for last year, an election statement must be prepared and attached to the return. The statement, which I can draft for you, must include specific information about the time, place and nature of the disaster that caused the loss.

Determining the most beneficial year in which to claim the loss requires a careful evaluation of your entire tax picture for both years, including filing status, amount of income and other deductions, and applicable tax rates. For example, claiming the loss in the higher income year may not be the most advantageous approach.  Because of a 10% of adjusted gross income (AGI) floor on personal (as contrasted with business or rental) casualty loss deductions, a larger amount of AGI will cut into your allowable loss deduction.  

On the other hand, if the larger income, or a smaller amount of other deductions, pushes you into a higher tax bracket, the deduction becomes more valuable. For example, a $4,000 deduction saves $1,240 for a taxpayer in the 31% tax bracket. A $4,000 deduction is worth $1,440 to a taxpayer in the 36% bracket.

Determining the amount of your loss

The amount of your loss is the difference in the fair market value (the price at which a willing seller would sell the property and a willing buyer would purchase the property) BEFORE the casualty and AFTER the casualty.  The loss is reduced by the amount of insurance you have received, or expect to receive.   The resulting reduction in fair market value may be reduced if your cost basis in the property (generally, what you paid for it, plus any capital improvements – such as a new roof, addition, pool, etc.), minus any prior casualty losses, is less.  There is also a 10% AGI limitation + $100 floor (or limitation) for personal casualty losses. 

Having pictures of the property immediately before and after the property will certainly help establish the extent of the loss.  A recent appraisal will also prove valuable.  The cost to repair the property (usually available from a licensed contractor) cannot be used solely as the basis for your deduction, but will be useful in the analytical process. 

HINT:  Establishing the value of your property immediately before a casualty can be a challenge.  One good source of information will be real estate listings for your area.  You can usually find these in various publications in the area where the property is located, as well as on line.  Gather this information NOW as it will be more difficult to obtain in the future. 

Gain after destruction of home or its contents.

If your family’s main home or its contents are destroyed as a result of a Presidentially declared disaster, you may realize a gain if the insurance payment you receive exceeds your basis (cost for tax purposes) for the property you lost. You don’t pay tax on any gain you realize due to insurance payments for unscheduled personal property (the home’s contents that were not scheduled property for insurance purposes) lost as a result of such a disaster. In addition, you have an easier time avoiding taxes on the gain you realize when the insurance proceeds you receive for your home and its scheduled contents exceeds your basis in these assets.

In general, when you lose your home to an event such as fire, flood, storm, etc., and your insurance company’s reimbursement exceeds your cost for the home, the gain can be tax-deferred if you timely reinvest the payment you received for the loss of your property in another home. The new home generally must be purchased no later than two years after the close of the first tax year in which you realized gain as a result of the property’s destruction. If your home is lost due to a disaster that is later a Presidentially declared disaster, the replacement period closes four years after the first tax year in which you realized gain as a result of the property’s destruction.

For purposes of the tax-deferred gain rules for loss of your home, a complicated rule allows you to treat the insurance proceeds for both the home and its scheduled contents as “a common pool of funds.” In simple terms, this rule makes it easier for you to avoid a current tax on the gain you realize as a result of the destruction of your property.

Because of my experience in this aspect of the tax law, I can determine if you have a deductible disaster loss, and make the necessary computations to properly advise you as to the most advantageous course of action. I can also show you how to defer the tax on any gain you realize as a result of the disaster.

If you are a victim of a Presidentially declared disaster, or simply want more information on this issue, please contact me. If you know someone (e.g., a friend or family member) who has suffered such a loss, I would be glad to review their particular situation with them.

Recent Court Case – estimate of loss while litigation in process

No theft loss deduction based on estimate of unrecoverable amount

Johnson v. U.S., (Ct Fed Cl 12/21/2006) 99 AFTR 2d ¶2007-308
The Court of Federal Claims has held that a taxpayer couldn’t claim a theft loss deduction after the year the loss was discovered based on an estimate of what was not recoverable through litigation. The taxpayer had to wait until litigation was complete before he could ascertain the amount of his loss with reasonable certainty.