Uninsured Homeowners Get Storm-damage Relief
Realty Tax Tips-Part 4: Do my real estate losses qualify?
Robert J. Bruss
Inman News
(This is Part 4 of an eight part series. Read Part 1, Part 2 and Part 3.)
Thankfully, 2006 was not a record year for U.S. casualty losses, unlike 2005. But 2006 was a year when property owners affected by Hurricanes Katrina, Rita and Wilma discovered their insurance companies weren't going to pay the full amounts expected.
The result is taxpayers can amend their 2005 income tax returns to claim refunds for qualifying casualty losses that occurred during that year.
Purchase Bob Bruss reports online.
WHAT IS A CASUALTY LOSS? A casualty loss is defined as a "sudden, unusual or unexpected" event resulting in an uninsured loss. Causes of such rapid losses include flood, fire, earthquake, wind damage, water damage, theft, accident, vandalism, hurricane, tornado, riot, snow, rain and ice.
To qualify for a casualty-loss tax deduction, at least part of the loss must be uninsured. If your entire loss was reimbursed by insurance payments, except for the policy deductible portion, you don't have a casualty-loss tax deduction.
When the president declares a federal disaster area, then affected taxpayers can either deduct their casualty loss in the tax year of the event or in the previous tax year by amending the prior year's tax return to claim an immediate tax refund from the previous year's tax payment.
THE LOSS MUST OCCUR QUICKLY. To be deductible, a casualty loss must occur quickly, usually instantly or over a few days. Slow losses that occur over months or years, such as dry rot or termite damage, are not tax-deductible.
Examples of nondeductible slow losses include rust, dry well, corrosion, moth damage, Dutch elm disease, erosion, drought, mold, beetle infestation, plant loss and tree death.
PERSONAL CASUALTY LOSSES HAVE LIMITATIONS. If your uninsured casualty loss did not involve business property, then only part of your personal loss is tax deductible.
The reason is only a personal casualty loss exceeding 10 percent of the taxpayer's annual adjusted gross income (line 37 of your 2006 federal tax return), minus a $100 nondeductible "floor" per event, is deductible.
However, if a sudden and uninsured casualty loss affected your business property, it is fully tax-deductible as a business expense.
To illustrate, suppose a flood damaged your home and you didn'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 cost you $175,000 several years ago. Your adjusted gross income for 2006 is $50,000.
To calculate your deductible casualty loss, use IRS Form 4684. Even though the house was worth $300,000 before the flood, your uninsured casualty loss is limited to the $175,000 adjusted cost basis, minus the $60,000 remaining land value, or $115,000. From that amount, 10 percent of your adjusted gross income or $5,000 must be subtracted and the $100 per event floor is also subtracted to arrive at a $109,900 deductible casualty loss in this example. The value of uninsured personal property also qualifies for this tax break.
If Hurricane Katrina, Rita or Wilma damaged your property, however, Congress and the IRS have waived the casualty-loss deduction limitations explained above. Details are in IRS Publication 4492, which is available by calling 1-800-829-3676 or going on the Internet to www.irs.gov/pub/irs-pdf/p4492.pdf.
NONDIRECT COSTS ARE ALSO DEDUCTIBLE. If you incurred nondirect costs related to your casualty loss, those costs are also deductible if they were not paid by insurance. Examples include temporary housing, moving expenses and property protection, such as board-up and legal fees.
INSURANCE PAYMENTS AFFECT YOUR CASUALTY-LOSS DEDUCTION. IRS casualty-loss rules require insured property owners to file claims for their insured losses with their insurance carriers.
But in recent years, many insured home and business owners became reluctant to file insurance claims for small amounts due to fear of policy cancellation or substantially increased premiums. So far, there is no evidence the IRS has denied casualty-loss deductions because the taxpayer didn't file an insurance claim.
When a large insurance payment to the insured exceeds the property's adjusted cost basis, and the insurance payment received is not used to replace, repair or rebuild, then the taxpayer has received taxable income from the excess insurance payment amount.
Taxpayers in federal disaster areas, such as those affected by hurricanes and floods, have up to four years to reinvest their excess insurance payments exceeding adjusted cost basis in repairs or replacement property to avoid owing capital gains tax on excess insurance payments.
However, this rule does not affect insurance payments for damaged or stolen personal property because insurance money exceeding the adjusted cost basis of personal property is not taxable even when the items are not replaced.
BE PREPARED WITH PROOF OF YOUR CASUALTY LOSS. The IRS loves to audit casualty-loss deductions. The reason is the IRS has discovered many casualty-loss claimants cannot prove their loss amounts.
With adequate proof of loss, casualty-loss claimants have nothing to fear. Although repair estimates alone are insufficient evidence of casualty losses, actual repair bills and receipts are excellent evidence to support a casualty-loss deduction.
Additional acceptable evidence of casualty losses includes police reports, photos of the lost or damaged property, and before-and-after appraisals. But market value at the time of the loss is irrelevant. What matters, as explained earlier, is the adjusted cost basis for the destroyed or damaged property.
CONCLUSION: If you incurred an uninsured "sudden, unusual or unexpected" casualty loss exceeding 10 percent of your 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 tax deduction. However, if your loss was due to Hurricane Katrina, Rita or Wilma, these deductible limitations do not apply. For full details, please consult your tax adviser.
Next week: Tax benefits of real estate investments.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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Copyright 2007 Inman News
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