While the heavy rains have ended and the water receded in parts, many individuals are beginning to evaluate the damage caused by Hurricane Harvey, and now Irma. The loss of life and property, as well as the emotional strain are hard to measure. But through the ordeal, many have come together to rebuild parts of the Houston area, Florida, and Georgia.
Tax laws are complex and may seem unfair at times, but in the area of natural disasters, such as Houston and Florida have endured, Congress provides some tax relief to those individuals afflicted in these situations. The tax relief won’t remove all the damage and heartache that has been done, but it attempts to offer some consolation. We would like to offer an overview of the tax impact some people may encounter as a result of the devastation caused by Harvey and Irma.
For the impacted property, first determine its damage and whether any insurance proceeds or reimbursements were received or will be received. The tax law permits a deduction for a loss incurred that is not covered or reimbursed by insurance. The tax law further provides that for a “casualty loss” (defined to include a sudden and unexpected event), a deduction is available for the partial or full destruction of damaged property. A sudden or unexpected event could include say, a fire, flood, tornado, or hurricane. The casualty loss is determined by the lesser of these amounts:
- The difference in the value of the property before the casualty event and the value after the event (or the decline in the property’s value);
- The adjusted basis (its original cost with some adjustments) of the affected property.
- This loss, however, is then reduced by any insurance proceeds received for the casualty.
The value of a house was $200,000 before the flood and was worth $60,000 after the flood. Its value had declined $140,000. If the basis in the property was $110,000, the casualty loss for tax purposes would be limited to $110,000. Next, assume the insurance proceeds from this event were only $20,000. The net casualty loss would be reduced to $90,000.
Casualty losses of individuals are then subject to certain limitations. First, each casualty is reduced by $100. Then, all casualty loss items are combined and these must exceed 10 percent of a taxpayer’s Adjusted Gross Income (AGI) for the year. Thus, in the previous example, assume the individual’s AGI is $120,000, then the casualty loss of $90,000 is first reduced by $100 and then reduced by $12,000 (10 percent of $120,000). The deductible casualty loss would then be $77,900. This loss is reported on IRS Form 4684 (see IRS Publication 547).
What would taxes be without a special exception? In an effort to speed up tax refunds for taxpayers impacted by a disaster, Congress put in a special provision that allows those in federal disaster areas (declared by the president) to claim their loss either in the year incurred or make a special election and deduct the loss in the previous year. The election to claim this loss in the prior year can be made on the prior year’s tax return if this return has not yet been filed, or on an amended tax return. Thus, if a taxpayer incurred a casualty loss from Harvey here in 2017 but had already filed their 2016 tax return, they could go and amend their 2016 tax return now to obtain their tax refund sooner. If they have not yet filed their 2016 tax returns (and the IRS has extended the due date for 2016 tax returns to January 31, 2018 for those impacted by Harvey and Irma), the casualty loss could be claimed on the 2016 tax return. There are several factors and issues to consider in making this special election, and impacted taxpayers may need counsel from a tax professional to decide which course to follow to achieve the most benefits.
New Tax Legislation:
On Friday, September 22, 2017, House Ways & Means Committee Chairman Kevin Brady of Texas introduced legislation to provide additional tax relief to those impacted by Hurricanes Harvey, Irma, and Maria. Several tax provisions in this legislation involve casualty losses as follows:
- First, for uncompensated losses arising in the disaster area, the legislation would eliminate the current law requirement that personal casualty losses must exceed 10 percent of AGI (addressed above) to qualify for a deduction.
- Next, the proposal would remove the current law requirement that taxpayers must itemize their deductions to access this tax relief for casualty losses.
- This bill moved through Congress quickly and was passed by both the House and Senate on September 28, 2017 and signed into law by the President on September 29, 2017. Click here to view a News Release from Mr. Brady on this tax legislation:
What about gains?
Much of the above discussion deals with casualty losses, as this is often the case with widespread disasters and flooding inflicted by hurricanes. But in some circumstances, a taxpayer may actually incur a gain from the casualty. There are special rules with gains (beyond the scope of this article), but professional advice is also needed to navigate the special rules to possibly reduce unexpected tax gains realized from destroyed property.
To recap, many people have incurred significant losses from Harvey and Irma. The rebuilding may take months, if not years. Taxes can play a part in this ordeal, hopefully offering some relief and not adding to individuals’ hardships. Please contact your Sikich tax advisor with any questions.