DISASTER LOSSES

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DISASTER LOSSES

Questions and Answers about Tax Relief for Taxpayers that have Disaster Losses

The following questions and answers highlight the basic federal tax treatment of disaster losses resulting from the damage or destruction of property in an area determined by the President to warrant federal disaster assistance. Throughout the Q-and-A, there are links to the required IRS documents and worksheets. If you have been affected by a disaster, you should consult your tax advisor for information about how these special tax rules may apply to you.

Overview

  1. What types of federal tax relief am I entitled to if I lost property in a disaster?

    You may be eligible for several types of federal income tax relief:

    • First, if you have disaster losses that are not fully reimbursed through insurance, you may claim a deduction for the year in which the loss occurred OR you may choose to deduct the loss in the prior year by filing an amended tax return. By taking the deduction in the prior year, you may receive an immediate tax refund.
    • Second, if your main home was damaged or destroyed and you received insurance payments that were more than the adjusted basis*, you can postpone paying tax on some or all of the gain if you buy a replacement property within the next four years.
      (*The adjusted basis of personal use property is generally the original purchase price, increased by the cost of additions or permanent improvements and decreased by any earlier casualty losses. For more information about how to calculate your adjusted basis, refer to IRS publication 551.)
    • Third, if you own a second property, such as a vacation home, and received insurance payments that were more than the adjusted basis for the loss of that property, you may be able to postpone some or all of the gain by buying replacement property -- but you must do so within the next two years, not four.
  2. How can I decide whether to amend my return from last year when my tax records were destroyed in the disaster?

    You can get copies of your prior tax returns and tax records by requesting them from the IRS on Form 4506 or Form 4506-T. Although the IRS usually charges a fee for this service, it will waive the fee and speed up your request because your records were lost due to a disaster. Just write the official Disaster Designation in red ink at the top of the form.

  3. How can I tell whether my casualty loss occurred in an area determined by the President to be a disaster area?

    You can find a list of the Presidentially declared disaster areas on the web site of the Federal Emergency Management Agency.

Claiming Disaster Loss Deductions for Personal Use Property

  1. How do I calculate my disaster loss?

    The easiest way to calculate your disaster loss is to take the lesser of the adjusted basis of the property, or the decrease in fair market value due to the disaster, and subtract any insurance or other reimbursement you received or expect to receive. For example, if a home with an adjusted basis of $80,000 and a value of $120,000 was completely destroyed and the owner received $70,000 in insurance payments, the owner's disaster loss would be $10,000. This is determined by taking the adjusted basis ($80,000), which is less than the decrease in fair market value ($120,000), and subtracting the insurance payments ($70,000). IRS Publication 547 explains how to calculate personal disaster losses.

  2. My home was worth $200,000 and now it is worth nothing, so I lost out on $200,000—not just the $150,000 I paid for it. Why is my tax loss so small?

    Under federal income tax law, a disaster loss is based on the lesser of the adjusted basis or the decrease in fair market value. In this case your disaster loss is based on your adjusted basis of $150,000, even though the decrease in fair market value is $200,000.

  3. If I have not yet filed an insurance claim, can I count the whole loss to figure out my tax deduction or do I have to count the insurance payments that I expect to receive?

    When you calculate your disaster loss, you must take into account the amount of insurance payments that you expect to receive, whether or not you have filed a claim. If you later receive less insurance money than was expected, you may include that difference as a loss for the year in which you expect no further insurance or other reimbursement. If you choose not to file an insurance claim, your disaster loss can not exceed the amount of your insurance deductible.

  4. Once I calculate the amount of my disaster loss, how much of it is deductible?

    After you calculate your disaster loss, there are two more steps to determine how much is deductible. First, you must subtract $100. Second, you must subtract 10% of your adjusted gross income. For example, if your disaster loss is $10,000 and your adjusted gross income is $50,000, you may deduct $4,900 of the loss, calculated as follows:

     $10,000 disaster loss
                  -100
              -5,000 (10% of adjusted gross income)
             $4,900 (disaster loss deduction)

    These calculations are made on IRS Form 4684, which must be attached to your federal income tax return. You must also indicate on the Form (or on a separate sheet) the date of the disaster and the city, town, county, and state in which the damaged or destroyed property was located.

  5. How do I decide whether it is better to take the disaster loss in the year of the disaster or in the prior year?

    This is an important question. You should calculate the tax benefit both ways and see which is greater. Since the disaster loss is deductible only to the extent it exceeds 10% of your adjusted gross income, it may be smarter to claim the loss in the year in which your income is lower. You will need to itemize deductions (instead of claiming the standard deduction) in order to claim the disaster loss deduction.

  6. How long do I have to decide whether to claim the disaster loss on an amended return for the prior year?

    You may choose to claim the disaster loss on an amended return for the prior year up to the due date (without extensions) of your tax return for the year in which the disaster actually occurred. For example, if you had a disaster loss in 2003 due to the California wildfires, you will have until April 15, 2004 to elect to amend your 2002 return and claim the disaster loss. If you decide to claim the disaster loss in the prior year, you should file IRS Form 1040X to adjust your deductions, and attach Form 4684 to calculate the disaster loss. Again, to speed up your refund, write the official Disaster Designation in red ink at the top of the form.

  7. How do I determine the reduction in my property's fair market value?

    The best way to determine the reduction in your property's fair market value is to have a professional appraisal. If you had an appraisal done to secure a federal loan through the federal disaster program, you can use that appraisal.

  8. Does the cost of the appraisal get added to my loss?

    No. The cost of the appraisal is considered a “miscellaneous itemized deduction” and may be deducted, with other miscellaneous itemized deductions, only to the extent that they exceed 2% of adjusted gross income.

  9. I don't own a home but my rental residence and its contents were destroyed. Can I claim a disaster loss for personal property even if I did not own a home?

    Yes. The disaster loss rules for renters are the same as for homeowners. Once you determine the lesser of the adjusted basis and the decrease in fair market value of the property, you then subtract the amount of insurance proceeds to determine the amount of the disaster loss. If you do not have any insurance, just skip that step when you calculate your loss.

Calculating Gain from Reimbursement for Loss of Personal Use Property

  1. The proceeds from my insurance coverage were more than the adjusted basis of the property I lost but less than the fair market value. Does that mean I can't take a tax deduction?

    Yes. Although the fair market value of the property may have been more than your adjusted basis, you don't have a loss for tax purposes. In fact, you have a gain and need to consider the tax treatment of that gain.

  2. What rules apply to gain resulting from insurance proceeds due to loss of my main home and/or contents as a result of a disaster?

    There are several special rules, which apply to renters as well as homeowners.

    • First, no gain is recognized on any insurance proceeds received for unscheduled personal property that was part of the contents of the home.
    • Second, any other insurance proceeds received for your main home or scheduled personal property are treated as received for a single item of property. You can postpone recognizing that gain for tax purposes by purchasing replacement property that it similar or related in service or use to the home or its contents and that has a cost equal to or greater than the insurance proceeds you received.
    • Third, if the insurance proceeds exceed the cost of replacement property, you have to recognize gain only to the extent of that excess.
       
  3. I have a gain from insurance proceeds I received from the destruction of my main home. How long do I have to purchase replacement property in order to postpone recognizing any gain?

    To postpone the gain, you must purchase replacement property (another home and/or its contents) within four years after the end of the year in which you realized the gain. You must reduce your basis in the replacement property by the amount of any postponed gain. You will be treated as having owned and used the replacement property as your main home for the entire period you owned the destroyed property. This will be important in determining the tax treatment when you dispose of the replacement property. Also note that some or all of the gain may be excludable, meaning no federal income tax will ever be levied upon it and it does not need to be postponed. See question and answer 7 below.

    For example, if your main home had an adjusted basis of $100,000 and you received $150,000 in insurance proceeds when it was destroyed, you have a tax gain of $50,000. You may postpone all of this gain by purchasing a replacement home (including contents) that costs at least $150,000 within four years. Your basis in the replacement home would be its cost less $50,000, the amount of the postponed gain. If your replacement home does not cost as much as the insurance proceeds, your tax gain will be limited to the excess of the insurance proceeds over the cost of the replacement property.

  4. To postpone the gain, do I have to use the insurance proceeds to purchase the new property or can I take out a mortgage?

    As long as the cost of the replacement property exceeds the insurance proceeds, you can use funds from any source, including a mortgage, to purchase the replacement property.

  5. How do I elect to postpone the gain?

    To elect to postpone the gain, you must attach a statement to your tax return for the year in which you have the gain. The statement must include the date and details of the disaster, the amount of insurance or other reimbursement received, the calculation of the gain being postponed, and it must say that you are electing to postpone the gain by purchasing replacement property. Then for each year during the replacement period in which you purchase replacement property, you must attach another statement to your return containing information about the replacement property. IRS Publication 547 explains the election procedure in more detail.

  6. What happens if I don't actually replace my property within the four-year period?

    If you do not replace your property within the required period, you will need to file an amended return for the year in which you received the insurance proceeds from the disaster to report the gain. If you purchase replacement property but it costs less than the amount of insurance proceeds, you will need to file an amended return also for the year you received the insurance proceeds, but the gain will be limited to the excess insurance proceeds.

  7. Instead of the special rule described above, can I just treat the insurance proceeds I received on the loss of my main home as if it had been sold for that amount?

    Yes. Under the normal rules that apply to gain from the sale of a main home, you may exclude a maximum of $250,000 ($500,000 if married and filing jointly). These rules are described in IRS Publication 523. If your gain is more than you can exclude under the normal rules, you can postpone reporting the gain by buying replacement property, as described above.

  8. The California wildfires destroyed my vacation home and I received insurance proceeds in excess of my adjusted basis. Can I elect to postpone that gain?

    Yes. However, the replacement period ends two years after the end of the year in which the gain is realized. The special four-year replacement period described above applies only to insurance payments received for the loss of your main home.

Disaster Losses and Gains for Business or Employee Property

  1. I have business property that was destroyed in a disaster. Is the tax loss calculated the same way for business property as for personal use property?

    Yes. To calculate the amount of disaster loss from business property, take the lesser of the adjusted basis of the property or the decrease in fair market value due to the disaster and subtract any insurance or other reimbursement that has been received or is expected. Business disaster losses are not subject to the $100 or the 10% adjusted gross income reductions that apply to individuals.

  2. Can a business elect to claim a disaster loss in the prior year?

    Yes. Businesses, like individuals, may elect to deduct disaster losses in the prior year by filing an amended return.

  3. What about gain from the receipt of insurance proceeds in excess of the adjusted basis of business property destroyed in a disaster? Is that calculated the same way as with respect to personal use property?

    Yes. If business property is destroyed and the insurance payments exceed the adjusted basis, there is a gain for tax purposes. The business may elect to postpone the gain by buying replacement property with a cost equal to or more than the insurance payments for business use within two years of the end of the tax year in which the gain was realized.

  4. I was required to purchase special uniforms for work and they were destroyed. Are there any special rules for deducting their loss on my taxes?

    The loss of property you used as an employee should be included in your “miscellaneous itemized deductions,” which are deductible if you itemize deductions to the extent they exceed 2% of your adjusted gross income.

Qualified Disaster Relief Payments:
Federal Loans, Charitable Assistance, Etc.

  1. What if I received a Small Business Association (SBA) Disaster Loan for my business or home? How will it affect my taxes?

    SBA loans are not treated as income and will not affect your taxes..

  2. I received money from a charitable organization, my employer, and friends to help pay for my temporary housing and other necessary expenses caused by the disaster. Does that count as income on my taxes?

    No. These payments are considered "qualified disaster relief payments" and they are not counted as income, regardless of the source, as long as the money went to expenses not covered by insurance or other reimbursements.

  3. Do I have to take "qualified disaster relief payments" into account when I calculate my disaster loss?

    Yes. If you receive qualified disaster relief payments that were meant to reimburse you for specific property losses, you should subtract the amount of those payments in calculating your losses in the same way as insurance payments.

  4. I made a contribution to a relief organization helping the victims of the hurricanes. Can I claim a deduction for that?

    You can claim a charitable contribution deduction only if the relief organization is a Section 501(c)(3) organization. You can check an organization's tax status by calling IRS customer service at 800-829-1040, or by visiting the IRS web site at http://www.irs.gov/charities/article/0,,id=96136,00.html. Remember to keep your cancelled check or receipt to substantiate the donation. If you contributed $250 or more, you will also need a tax acknowledgment letter from the organization to claim the deduction.

  5. I gave some money to a co-worker in need because of the Hurricane Ivan. Can I deduct that donation on my taxes?

    No. Donations to individuals do not qualify as charitable contributions.

Need More Information?
  • For more information about the federal income tax treatment of disaster losses and gains, visit the IRS web site at www.irs.gov.




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