(This is Part 4 of an eight part series.)
Thankfully, 2006 was not a record year for U.S. casualtylosses, unlike 2005. But 2006 was a year when property owners affected byHurricanes Katrina, Rita and Wilma discovered their insurance companies weren’tgoing to pay the full amounts expected.
The result is taxpayers can amend their 2005 income taxreturns to claim refunds for qualifying casualty losses that occurred duringthat year.
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WHAT IS A CASUALTY LOSS? A casualty loss is definedas a “sudden, unusual or unexpected” event resulting in an uninsuredloss. Causes of such rapid losses include flood, fire, earthquake, wind damage,water damage, theft, accident, vandalism, hurricane, tornado, riot, snow, rainand ice.
To qualify for a casualty-loss tax deduction, at leastpart of the loss must be uninsured. If your entire loss was reimbursed byinsurance payments, except for the policy deductible portion, you don’t have acasualty-loss tax deduction.
When the president declares a federal disaster area, thenaffected taxpayers can either deduct their casualty loss in the tax year of theevent or in the previous tax year by amending the prior year’s tax return toclaim an immediate tax refund from the previous year’s tax payment.
THE LOSS MUST OCCUR QUICKLY. To bedeductible, a casualty loss must occur quickly, usually instantly or over a fewdays. Slow losses that occur over months or years, such as dry rot or termitedamage, are not tax-deductible.
Examples of nondeductible slow losses include rust, drywell, corrosion, moth damage, Dutch elm disease, erosion, drought, mold, beetleinfestation, plant loss and tree death.
PERSONAL CASUALTY LOSSES HAVE LIMITATIONS. If youruninsured casualty loss did not involve business property, then only part ofyour personal loss is tax deductible.
The reason is only a personal casualty loss exceeding 10percent of the taxpayer’s annual adjusted gross income (line 37 of your 2006federal tax return), minus a $100 nondeductible “floor” per event, isdeductible.
However, if a sudden and uninsured casualty loss affectedyour business property, it is fully tax-deductible as a business expense.
To illustrate, suppose a flood damaged your home and youdidn’t have flood insurance. Before the flood, your house was worth $300,000.But after the flood all that is left is land value of $60,000. The house costyou $175,000 several years ago. Your adjusted gross income for 2006 is $50,000.
To calculate your deductible casualty loss, use IRS Form4684. Even though the house was worth $300,000 before the flood, your uninsuredcasualty loss is limited to the $175,000 adjusted cost basis, minus the $60,000remaining land value, or $115,000. From that amount, 10 percent of youradjusted gross income or $5,000 must be subtracted and the $100 per event flooris also subtracted to arrive at a $109,900 deductible casualty loss in thisexample. The value of uninsured personal property also qualifies for this taxbreak.
If Hurricane Katrina, Rita or Wilma damaged your property,however, Congress and the IRS have waived the casualty-loss deductionlimitations explained above. Details are in IRS Publication 4492, which isavailable by calling 1-800-829-3676 or going on the Internet to
NONDIRECT COSTS ARE ALSO DEDUCTIBLE. If youincurred nondirect costs related to your casualty loss, those costs are alsodeductible if they were not paid by insurance. Examples include temporaryhousing, moving expenses and property protection, such as board-up and legalfees.
INSURANCE PAYMENTS AFFECT YOUR CASUALTY-LOSS DEDUCTION. IRScasualty-loss rules require insured property owners to file claims for theirinsured losses with their insurance carriers.
But in recent years, many insured home and business ownersbecame reluctant to file insurance claims for small amounts due to fear ofpolicy cancellation or substantially increased premiums. So far, there is noevidence the IRS has denied casualty-loss deductions because the taxpayerdidn’t file an insurance claim.
When a large insurance payment to the insured exceeds theproperty’s adjusted cost basis, and the insurance payment received is not usedto replace, repair or rebuild, then the taxpayer has received taxable incomefrom the excess insurance payment amount.
Taxpayers in federal disaster areas, such as those affectedby hurricanes and floods, have up to four years to reinvest their excessinsurance payments exceeding adjusted cost basis in repairs or replacementproperty to avoid owing capital gains tax on excess insurance payments.
However, this rule does not affect insurance payments fordamaged or stolen personal property because insurance money exceeding theadjusted cost basis of personal property is not taxable even when the items arenot replaced.
BE PREPARED WITH PROOF OF YOUR CASUALTY LOSS. The IRSloves to audit casualty-loss deductions. The reason is the IRS has discoveredmany casualty-loss claimants cannot prove their loss amounts.
With adequate proof of loss, casualty-loss claimants havenothing to fear. Although repair estimates alone are insufficient evidence ofcasualty losses, actual repair bills and receipts are excellent evidence tosupport a casualty-loss deduction.
Additional acceptable evidence of casualty losses includespolice reports, photos of the lost or damaged property, and before-and-afterappraisals. But market value at the time of the loss is irrelevant. Whatmatters, as explained earlier, is the adjusted cost basis for the destroyed ordamaged property.
CONCLUSION: If you incurred an uninsured”sudden, unusual or unexpected” casualty loss exceeding 10 percent ofyour annual adjusted gross income, minus a $100 per event “floor,”Uncle Sam wants to help share your loss in the form of the casualty-loss taxdeduction. However, if your loss was due to Hurricane Katrina, Rita or Wilma,these deductible limitations do not apply. For full details, please consultyour tax adviser.
Next week: Tax benefits of real estate investments.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
Copyright 2007 Inman News