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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.
You may be eligible for several types of federal income tax relief:
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.
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
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.
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.
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.
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
-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.
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.
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.
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.
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.
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
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.
There are several special rules, which apply to renters as well as homeowners.
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.
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.
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.
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.
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.
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
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.
Yes. Businesses, like individuals, may elect to deduct disaster losses in the prior year by filing an amended return.
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.
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.
SBA loans are not treated as income and will not affect your 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.
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.
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.
No. Donations to individuals do not qualify as charitable contributions.