MarketWatch.com:
By Bill Bischoff
In addition to the tragedy of lost lives and injuries, Superstorm Sandy caused many billions of dollars in property damage. The sad truth: disasters occur every year in America. If you’re unlucky enough to suffer a disaster-related casualty, here’s what you need to know about the federal income tax implications.
Deductions for Personal Casualty Losses
Theoretically, our beloved Internal Revenue Code allows you to claim an itemized deduction — on Schedule A of your Form 1040 — for personal casualty losses to the extent they are not covered by insurance. Exactly what is a casualty loss? It’s when the fair market value of your property or asset is reduced or wiped out by a hurricane, flood, storm, fire, earthquake or volcanic eruption (not to mention sonic boom, theft or vandalism).
In reality, however, many disaster victims won’t qualify for any personal casualty loss write-offs because of the following two rules. First, you must reduce your loss by $100. Obviously, that’s no big deal. Then you must further reduce the loss by an amount equal to 10% of your adjusted gross income (AGI) for the year (AGI is the number at the bottom of page 1 of your Form 1040). That is a big deal. Say you incur a $20,000 personal casualty loss this year and have AGI of $100,000. Your write-off is a relatively puny $9,900 ($20,000 minus $100 minus $10,000). You get absolutely no tax break if your loss before the two required subtractions is $10,100 or less, and you have no chance at all if you don’t itemize.
But let’s assume you do have a deductible personal casualty loss from a 2012 event after the two subtractions. If the loss was caused by a disaster in a federally declared disaster area (more on that later), a special rule allows you to claim your rightful deduction either this year or last year. For example, victims of Hurricane Sandy can file amended 2011 returns and claim their losses last year. This rule allows you to get some immediate tax savings instead of having to wait until next year when you finally get around to filing your 2012 return. Remember: this special rule is only available for losses in federally declared disaster areas. You can find a by-state listing of these areas by using the interactive map on the Federal Emergency Management Agency (FEMA) website at www.fema.gov .
Deductions for Business Casualty Losses
If you have disaster-related losses to business assets, you don’t have to worry about the $100 subtraction rule or the 10%-of-AGI subtraction rule. Instead, you can deduct the full amount of your uninsured loss as a business expense. As with personal casualty losses, you have the option of claiming 2011 deductions for 2012 losses that occur in a federally declared disaster area.
Watch Out: You Might Have a Taxable Involuntary Conversion Gain
When you have insurance coverage for disaster-related property damage — under a homeowners, renters, or business policy — you might actually have a taxable gain instead of a deductible casualty loss. Why? Because if the insurance proceeds exceed the tax basis of the damaged or destroyed property (normally equal to its cost), you have a taxable profit as far as the IRS is concerned. This is the case even if the insurance company doesn’t fully compensate you for the pre-casualty value of the property. These gains are called involuntary conversion gains — because the casualty event causes your property to suddenly be converted into cash from the insurance proceeds.
For example, you could have a big involuntary conversion gain if your valuable vacation home is heavily damaged or destroyed and your insurance coverage greatly exceeds what you paid for the property when you bought it years ago.
If you have an involuntary conversion gain, it generally must be reported as income on your Form 1040 unless you (1) make sufficient expenditures to repair or replace the property and (2) make a special tax election to defer the gain. If you make the election (you generally should), you have a taxable gain only to the extent the insurance proceeds exceed what you spend to repair or replace the property. The expenditures for repairs or replacement generally must occur within the period beginning on the date the property was damaged or destroyed and ending two years after the close of the tax year in which you have the involuntary conversion gain.
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By Bill Bischoff
In addition to the tragedy of lost lives and injuries, Superstorm Sandy caused many billions of dollars in property damage. The sad truth: disasters occur every year in America. If you’re unlucky enough to suffer a disaster-related casualty, here’s what you need to know about the federal income tax implications.
Deductions for Personal Casualty Losses
Theoretically, our beloved Internal Revenue Code allows you to claim an itemized deduction — on Schedule A of your Form 1040 — for personal casualty losses to the extent they are not covered by insurance. Exactly what is a casualty loss? It’s when the fair market value of your property or asset is reduced or wiped out by a hurricane, flood, storm, fire, earthquake or volcanic eruption (not to mention sonic boom, theft or vandalism).
In reality, however, many disaster victims won’t qualify for any personal casualty loss write-offs because of the following two rules. First, you must reduce your loss by $100. Obviously, that’s no big deal. Then you must further reduce the loss by an amount equal to 10% of your adjusted gross income (AGI) for the year (AGI is the number at the bottom of page 1 of your Form 1040). That is a big deal. Say you incur a $20,000 personal casualty loss this year and have AGI of $100,000. Your write-off is a relatively puny $9,900 ($20,000 minus $100 minus $10,000). You get absolutely no tax break if your loss before the two required subtractions is $10,100 or less, and you have no chance at all if you don’t itemize.
But let’s assume you do have a deductible personal casualty loss from a 2012 event after the two subtractions. If the loss was caused by a disaster in a federally declared disaster area (more on that later), a special rule allows you to claim your rightful deduction either this year or last year. For example, victims of Hurricane Sandy can file amended 2011 returns and claim their losses last year. This rule allows you to get some immediate tax savings instead of having to wait until next year when you finally get around to filing your 2012 return. Remember: this special rule is only available for losses in federally declared disaster areas. You can find a by-state listing of these areas by using the interactive map on the Federal Emergency Management Agency (FEMA) website at www.fema.gov .
Deductions for Business Casualty Losses
If you have disaster-related losses to business assets, you don’t have to worry about the $100 subtraction rule or the 10%-of-AGI subtraction rule. Instead, you can deduct the full amount of your uninsured loss as a business expense. As with personal casualty losses, you have the option of claiming 2011 deductions for 2012 losses that occur in a federally declared disaster area.
Watch Out: You Might Have a Taxable Involuntary Conversion Gain
When you have insurance coverage for disaster-related property damage — under a homeowners, renters, or business policy — you might actually have a taxable gain instead of a deductible casualty loss. Why? Because if the insurance proceeds exceed the tax basis of the damaged or destroyed property (normally equal to its cost), you have a taxable profit as far as the IRS is concerned. This is the case even if the insurance company doesn’t fully compensate you for the pre-casualty value of the property. These gains are called involuntary conversion gains — because the casualty event causes your property to suddenly be converted into cash from the insurance proceeds.
For example, you could have a big involuntary conversion gain if your valuable vacation home is heavily damaged or destroyed and your insurance coverage greatly exceeds what you paid for the property when you bought it years ago.
If you have an involuntary conversion gain, it generally must be reported as income on your Form 1040 unless you (1) make sufficient expenditures to repair or replace the property and (2) make a special tax election to defer the gain. If you make the election (you generally should), you have a taxable gain only to the extent the insurance proceeds exceed what you spend to repair or replace the property. The expenditures for repairs or replacement generally must occur within the period beginning on the date the property was damaged or destroyed and ending two years after the close of the tax year in which you have the involuntary conversion gain.
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