Tax Relief in a Federally-Declared Disaster Area

On January 2, the President declared a major natural disaster for those areas affected by the Thomas Fire. Montecito’s recent mudslides brought another natural disaster to an already-scarred community. If you or someone you know was directly affected by these damaging events, please read the following tips on how taxpayers may be able to seek tax relief and deduct the loss incurred on their federal tax return.

Taxpayers are typically able to claim a deduction if they experience a major loss that is not reimbursed by insurance or other form of recovery.

Here are tips to consider during disaster recovery:

1. Casualty Loss: Under law for the 2017 tax filing season, you may be able to claim a deduction for personal losses sustained from wildfires, tornadoes, floods, earthquakes and other natural disasters. It also allows tax loss claims for accidents, thefts or vandalism. Starting in 2018, however, the casualty loss deduction can only be claimed in a disaster that is declared by the President.

A major disaster declaration has been issued for the Thomas Fire and related flooding, mudflows and debris flows directly related to the wildfire. Visit https://www.fema.gov/disaster/4353/notices to read the Initial Notice regarding the wildfires and subsequent amendments including related flooding, mudflows and debris flows.

Disaster assistance with FEMA is now available to both individuals and businesses. Those who suffered damages and losses from the wildfires and mudslides may now register for disaster assistance with FEMA. The following link provides more details: http://www.oesnews.com/southern-california-residents-may-register-for-disaster-assistance/. Assistance received from FEMA is nontaxable and will not affect eligibility for other federal benefits.

Also, victims (including businesses, nonprofit organizations, homeowners and renters) must first register with FEMA at www.disasterassistance.gov to receive a FEMA registration number, before applying to the U.S. Small Business Administration at https://disasterloan.sba.gov/ela/Information/Index to qualify for a low rate SBA disaster loan.

2. Calculating Gain or Loss Amount: According to the IRS, consider the following steps when calculating the total amount of casualty loss.

a. Determine the adjusted basis in the property before the casualty. For property a taxpayer buys, the basis is usually its cost to them. For property they acquire in some other way, such as inheriting it or getting it as a gift, the basis is determined differently. For more information, see Publication 551, Basis of Assets.

b.  Determine the decrease in fair market value, or FMV, of the property as a result of the casualty. FMV is the price for which a person could sell their property to a willing buyer. The decrease in FMV is the difference between the property’s FMV immediately before and immediately after the casualty.

c.  Subtract any insurance or other reimbursement received or expected to receive from the smaller of those two amounts.

3. $100 rule: When a taxpayer has calculated the total casualty loss on personal-use property, the rule of thumb is to reduce that amount by $100. This is applied per event during the year and can include any number of pieces of property involved in that particular event.

4. 10 Percent Rule: Reduce the annual total casualty loss on personal-use property by 10 percent of your adjusted gross income.

5. Insurance Coverage: Taxpayers must file a timely claim for reimbursement for their loss; otherwise, they cannot deduct the loss as a casualty or theft. Reduce the loss by the amount of the reimbursement received or anticipated. Check with your insurance agent for more information. You may also consider joining public discussion groups to learn how others are approaching their claims.

6. When to Deduct: Generally, a casualty loss is deducted in the year the loss occurred. However, there is a provision for federally declared disasters, such as the recent Thomas Fire or Montecito mudslides, where you may have a choice on when you wish to take the deduction. In these cases, a taxpayer may claim the loss in the year the loss occurred or have the option to claim it on an original or amended return for the immediately preceding year. For example, since casualty loss regulations shifted from 2017 to 2018 under the new tax reform law, a mudslide victim may consider taking the loss on their 2017 tax return should insurance fail to cover some or all of the damage. This means the taxpayer does not have to wait until next year to claim the loss. It also means that claiming the disaster loss on the 2017 return may result in a lower tax for that year. Be sure to subtract any insurance reimbursement or anticipated reimbursement from the total loss amount.

7. GoFundMe Donations: Donations made on GoFundMe pages are usually considered to be “personal gifts” and not taxed as income.

8. Normal Wear and Tear: A casualty loss does not include losses from normal wear and tear, including progressive deterioration from age or termite damage.

9. Future Income: The loss of future profits or income are not considered in the loss due to the disaster.

Business/Income Property: There are a few differences between the rules for property held for personal use and that of business or income-producing property. Please be sure to seek guidance from your advisor before claiming business or income property casualty losses.

11. Disaster Gains: In some cases, insurance proceeds may be in excess of the adjusted basis of your main home. This would result in a casualty gain. Further relief may be available where taxpayers can postpone the recognition of that gain if you purchase property that is similar or related in service or use to the destroyed property within the replacement period. For more information on the postponement of casualty gains, see Publication 547, Casualties, Disasters, and Thefts.

Tax season officially begins on Monday, January 29 for the 2017 filing year. Returns are due on Tuesday, April 17. To report a casualty loss on a federal tax return, complete Form 4684, Casualties and Thefts, and claim the deductible amount on Schedule A, Itemized Deductions.

We are here to help. Our community has experienced devastation and no one should have to feel lost in navigating tax-related disaster recovery planning. Please contact your advisor at (805) 963-7811 or ask to speak with a tax professional who can walk you through this process step by step.