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Navigating the Aftermath: Understanding Disaster Loss Tax Provisions for Homeowners Affected by Disasters
June 2024
Navigating the Aftermath: Understanding Disaster Loss Tax Provisions for Homeowners Affected by Disasters
by: Rose, Snyder & Jacobs LLP
In recent years, wildfires, hurricanes, and other natural disasters have become increasingly frequent and devastating, leaving many individuals and families grappling with the loss of their homes and personal property. For those affected by such disasters, particularly in areas designated as federal disaster zones, understanding the tax implications and available relief options is crucial. This article delves into the various disaster loss tax provisions, including the limitations, claims process, and tax treatments associated with qualified disaster losses. We will explore the intricacies of claiming losses, the election to claim losses on prior year returns, and the tax implications of insurance payments and FEMA assistance.
Understanding Qualified Disaster Losses – A qualified disaster loss refers to a casualty or theft loss of personal-use property, including a personal residence, attributable to a major disaster declared by the President. These losses are subject to specific provisions that allow taxpayers to claim deductions, even if they do not itemize their deductions. The per-event limitations for qualified disaster losses include an increase in the standard deduction and a waiver of the 10% of adjusted gross income (AGI) reduction, although a $500 per casualty threshold applies.
Specifically, each casualty loss must exceed $500 to be deductible. This threshold is in place to prevent taxpayers from claiming deductions for minor losses, ensuring that only significant losses are eligible for tax relief.
Claiming a Qualified Disaster Loss – The loss can be claimed in the year it occurred or, alternatively, on the prior year’s return, which if already filed would have to be amended. This flexibility allows taxpayers to potentially receive a quicker tax refund, providing much-needed financial relief.
However, if there is a reasonable prospect of reimbursement, the deduction is deferred until the reimbursement is determined. If the determination cannot be made by the return due date, then an extension can be filed extending the due date until October 15th. If October 15 falls on a holiday or weekend, the due date is the next business day.
Election to Claim Loss on Prior Year Amended Return – Taxpayers can elect to claim their disaster loss on the prior year’s return, and if that return has already been filed, filing it can be amended to claim the disaster loss. This election must be made within six months after the due date of the taxpayer’s federal income tax return for the disaster year, without regard to extensions. The election statement should include details of the disaster, the location of the damaged property, and the amount of the loss.
Claiming a disaster loss in the prior year can provide several benefits:
Quicker Access to Refunds: By claiming the loss on the prior year’s tax return, you may receive a tax refund more quickly than if you wait to claim it on the current year’s return.
Potential for Greater Tax Benefit: Depending on your income and tax situation, claiming the loss in the prior year might result in a larger tax benefit. This is because the tax rates or your income level might have been different, potentially leading to a greater reduction in taxable income.
Flexibility in Tax Planning: Electing to claim the loss in the prior year gives you the flexibility to choose the year that provides the most advantageous tax outcome.
Relief for Some Non-Itemizers – Normally taxpayers who aren’t itemizing deductions don’t include Schedule A in their return. However, taxpayers who are not itemizing and who have a net qualified disaster loss are eligible to claim both the qualified disaster loss and the standard deduction.
Net Operating Loss Deduction – A disaster loss Net Operating Loss (NOL) is created when a taxpayer’s allowable disaster-related losses exceed their income for the year. These losses are treated as “business” losses for the purpose of computing NOLs. When a disaster loss occurs, taxpayers in the affected area may be eligible to claim these losses as NOLs. This allows them to potentially offset taxable income in other years, by carrying the loss forward to future tax years.
For those familiar with NOLs, at one time an NOL could be carried back some years and then forward. However, per current law NOLs can only be carried forward until used up.
Insurance Coverage and Reimbursement – Insurance coverage plays a critical role in disaster recovery. Proceeds from insurance claims must be considered when calculating the deductible loss. If insurance reimbursement is received for living expenses, it is generally not taxable unless it exceeds the actual expenses incurred.
Taxation of FEMA Assistance Payments – FEMA assistance payments are typically not taxable. These payments are intended to help cover essential needs and expenses not covered by insurance. However, any payments received for expenses that are later reimbursed by insurance must be reported as income.
To apply for FEMA assistance after suffering a disaster loss, you can follow these steps:
File a Claim with Your Insurance: Before applying for FEMA assistance, you must file a claim with your insurance company. FEMA cannot duplicate benefits for losses covered by insurance.
Apply for FEMA Assistance: There are three ways to apply:o Online: Visit DisasterAssistance.gov to apply online. This is the easiest and fastest method if you have internet access and power.
o FEMA App: Use the FEMA App on your mobile device to apply.
o Phone: Call the FEMA Helpline at 1-800-621-3362. The helpline is available every day from 4 a.m. to 10 p.m. Pacific Standard Time. Assistance is available in most languages. If you use a relay service, provide FEMA with the number for that service.
For more information on the types of assistance available, you can visit fema.gov/assistance/individual/program. There is also an accessible video on how to apply available on YouTube titled “FEMA Accessible: Registering for Individual Assistance”.
When Disaster Losses Might Result in a Gain – In some cases, insurance proceeds may exceed the adjusted basis of the destroyed property, resulting in a gain. Taxpayers can defer this gain by purchasing replacement property within a specified period, under the involuntary conversion rules of Section 1033.
Involuntary Conversions – IRC Section 1033 allows taxpayers to defer gains from involuntary conversions, such as those resulting from insurance proceeds exceeding the property’s basis. To qualify, replacement property must be purchased within a specified timeframe.
This provision helps taxpayers avoid immediate tax liabilities that could arise from such conversions, allowing them to maintain their financial stability while replacing their lost or damaged property.
The general rule under Section 1033 is that taxpayers have two years (four in the case of a disaster) after the close of the first tax year in which any part of the gain is realized to reinvest in similar or related property.
Debris Removal and Demolition Expenses – Debris removal and demolition expenses are generally not deductible in the year of a disaster loss. The treatment of these expenses depends on their nature:
Demolition Expenses: The costs of demolishing structures are typically not deductible. Instead, these costs are charged to the capital account of the underlying land.
Debris Removal Expenses: If the debris removal costs are related to the replacement of part of the property that was damaged, these costs are capitalized and added to the taxpayer’s basis in the property.
Filing Extensions – When the President declares a disaster the IRS also provides filing and payment relief for individuals and businesses within the disaster area. These dates are different for each disaster and provided online at the IRS website. As an example, the following are the extended due dates for the 2025 Los Angeles wildfires.
The Internal Revenue Service announced tax relief for individuals and businesses in southern California affected by wildfires and straight-line winds that began on Jan. 7, 2025.
The tax relief postpones various tax filing and payment deadlines that occurred from Jan. 7, 2025, through Oct. 15, 2025 (postponement period). As a result, affected individuals and businesses will have until Oct. 15, 2025, to file returns and pay any taxes that were originally due during this period.