ROBERT L. SOMMERS
Note: This exercise is for educational purposes only and is not intended to be legal or tax advice. Your particular facts and circumstances must be considered when applying the U.S. tax law. You should always consult with a competent tax professional with respect to your particular situation.
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Floods, fires, earthquakes, mud slides. Californians have
suffered their share of such disasters. The tax law provides
relief, but the rules are complex. A deduction for a casualty
loss involves the following issues: (1) Was the property insured;
(2) Was the loss suffered by a sudden event (a
"casualty"); (3) Was the property personal or used in a
trade or business; (4) Did the president declare a national
disaster; and (5) Is the property your principal residence?
A casualty loss is the difference between the property's fair
market value immediately before and after the casualty, as
determined by a professional appraisal. However, the loss amount
is limited to the property's basis (generally the cost of the
property, plus improvements). Example: A home valued at $225,000
is flooded and immediately thereafter is worth only $100,000. If
the home's basis was $150,000, $125,000 would be the total
casualty loss -- well under the ceiling of the home's original
basis of $150,000. If the home's basis was $75,000, then the loss
would be capped at $75,000. In addition, each casualty loss is
subject to a $100 deduction, therefore, the amount remaining
after applying the $100 deductible is your casualty loss. The
loss is claimed as an itemized deduction on Schedule A of your
Form 1040. Form 4684 is used to report casualty gains and losses
of nonbusiness property.
The tax loss deduction must be reduced by any insurance or
reimbursement received. A loss cannot be deducted if it was
covered by insurance, but you fail to file a timely claim for the
loss. If the amount of insurance or reimbursement received
exceeds you basis in the property, you would have a casualty
gain. Casualty gains and losses are netted against each other.
A casualty is usually a single sudden, unexpected or usual
event, such as fire, earthquake, flood, hurricane, explosion,
vandalism, sonic boom, waves and winds. Unintentional damage to
an automobile can be a casualty. Gradual decay or destruction
(termite, dry rot or pollution damage) are not considered
casualties by the IRS.
Losses to personal property (except a principal residence,
described below) are limited to casualty gains, plus the excess
over 10% of the taxpayer's adjusted gross income (AGI). For
example, if the taxpayer has $50,000 in AGI, a casualty gain of
$10,000 and a casualty loss of $30,000 (after the $100
deductible), then $15,000 would be deductible (10% of AGI is
$5,000; $30,000 loss - $10,000 gain = $20,000 net loss; $20,000
less $5,000 = $15,000 deductible).
Trusts and estates may claim a casualty loss as if they were
individuals, except that their administrative expenses are
deducted as part of AGI. Business losses are usually fully
deductible without any AGI limitations.
When you lose property in a presidentially declared disaster
("disaster loss"), other rules apply. You may elect to
deduct the loss in the current or preceding year. This decision
must be made by the filing date of the return for the year in
which the disaster occurred. The election may also be made by
amending last year's tax return to declare the loss, which could
provide you with an immediate tax refund. AGI limitations for the
preceding year apply with this option.
For business owners, new legislation permits you to replace
any "tangible" property (generally, property other than
real estate) used in your business with any other tangible
business property without any imposition of taxation. This will
permit business owners suffering a casualty loss to use the
insurance or other proceeds for a new venture. Example: the owner
of a restaurant who suffers a disaster loss may use the insurance
proceeds to buy computer equipment for a new consulting venture.
This rule will apply to disasters after December 31, 1994.
If you suffer damage to your principal residence or its
contents from a disaster loss, you may replace your home and
contents (provided those contents were not separately scheduled
for insurance purposes) within four years after the end of the
first taxable year in which you receive the insurance proceeds.
For example, if you lose your home in October 1992, but do not
receive the insurance proceeds until May 1993, you have until
December 31, 1997, to replace your home and contents tax-free
(four years after the close of the first year you receive the
proceeds). These rules also apply to renters who have insured
their household contents.
Loss of your home and its contents is considered a single item of property so that insurance proceeds can be considered a single pool of funds with which to replace your home and contents. You will recognize a gain only if the pool of funds exceeds the cost of replacing your home and contents.
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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**