Tax advisors are already working hard to determine how the IRS disaster relief announcements and Internal Revenue Code will impact disaster victims, and those who reside in disaster areas. While the first thoughts of many are how they are able to extend income tax returns that are due October 15th 2022 to February 15th, 2023 and whether they can deduct losses and home restoration costs. But there is much more to know and consider.
All residents of Florida, South Carolina and Georgia already qualify under many unique rules, regardless of if they were affected, but that seems fair, because tax professionals in these States will have great challenges working with incomplete records, staffing issues, financially and emotionally distraught clients, and many corporate challenges.
Here is a guide to some of the tax issues.
Section 139 Qualified Disaster Payments to Employees and Contractors Are Not Taxable to the Recipient
Employers should keep in mind that they can pay certain expenses for employees under Internal Revenue Code Section 139 as deductible expenses that the employee or independent contractor will not have to include in income, and the employer will be able to deduct, and not have to pay employment taxes, workers compensation, unemployment compensation or pension contributions moneys on.
Employers may therefore ask their tax advisors about providing qualified disaster payments in lieu of future bonuses or other forms of compensation.
This can apply even when the only payments are made to an owner or relatives of the owner of an S corporation or a C corporation. It may not apply to payments made by a partnership to a partner, but if the partner puts his or her partnership interest into an S corporation before the payment is made, then it may qualify.
A qualified disaster relief payment is any amount paid to or for the benefit of a person to reimburse or pay reasonable and necessary personal, family, living or funeral expenses that are a result of a qualified disaster.
In addition, amounts paid to reimburse or pay for reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or the repair or replacement of the contents of a personal residence that is attributable to the disaster will also qualify to the extent attributable to a qualified disaster. This can be a vacation home, but probably not a home that is rented to someone other than the employee or independent contractor.
However, the above expenses qualify only to the extent that what was paid for is not compensated by insurance or other sources, and amounts received as Section 139 payments cannot be deducted as casualty losses, so there can be no double dipping.
A qualified disaster includes a federally declared disaster, and therefore applies to damages from hurricane Ian in any and all counties in Florida, Georgia and South Carolina.
(I will be presenting a free webinar on Section 139, casualty laws and other disaster relief issues with Karl Mills on Wednesday, October 5, 2022 at 4:00 PM. Karl specializes in representing charitable organizations and structuring charitable arrangements. He will be discussing disaster relief fund opportunities and other planning. Please feel free to send us any questions in advance. Please e-mail info@gassmanpa.com and we will send you an invite and also review your questions for our free webinar, as well as a link to view the recording of the webinar after it has been completed.)
For those of you who are CPA’s, tax lawyers and gluttons for punishment (if you have not suffered enough already) IRC § 139 reads as follows:[1]
(a) General rule
Gross income shall not include any amount received by an individual as a qualified disaster relief payment.
(b) Qualified disaster relief payment defined
For purposes of this section, the term “qualified disaster relief payment” means any amount paid to or for the benefit of an individual—
(1) to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster,
(2) to reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replacement of its contents to the extent that the need for such repair, rehabilitation, or replacement is attributable to a qualified disaster,
(3) by a person engaged in the furnishing or sale of transportation as a common carrier by reason of the death or personal physical injuries incurred as a result of a qualified disaster, or
(4) if such amount is paid by a Federal, State, or local government, or agency or instrumentality thereof, in connection with a qualified disaster in order to promote the general welfare,
but only to the extent any expense compensated by such payment is not otherwise compensated for by insurance or otherwise.
(c) Qualified disaster defined
For purposes of this section, the term “qualified disaster” means—
(1) a disaster which results from a terroristic or military action (as defined in section 692(c)(2)),
(2) a federally declared disaster (as defined by section 165(i)(5)(A)),
(3) a disaster which results from an accident involving a common carrier, or from any other event, which is determined by the Secretary to be of a catastrophic nature, or
(4) with respect to amounts described in subsection (b)(4), a disaster which is determined by an applicable Federal, State, or local authority (as determined by the Secretary) to warrant assistance from the Federal, State, or local government or agency or instrumentality thereof.
(d) Coordination with employment taxes
For purposes of chapter 2 and subtitle C, qualified disaster relief payments and qualified disaster mitigation payments shall not be treated as net earnings from self-employment, wages, or compensation subject to tax.
(e) No relief for certain individuals
Subsections (a), (f), and (g) shall not apply with respect to any individual identified by the Attorney General to have been a participant or conspirator in a terroristic action (as so defined), or a representative of such individual.
(f) Exclusion of certain additional payments
Gross income shall not include any amount received as payment under section 406 of the Air Transportation Safety and System Stabilization Act.
(g)Qualified disaster mitigation payments1) In general
Gross income shall not include any amount received as a qualified disaster mitigation payment.
(2) Qualified disaster mitigation payment defined
For purposes of this section, the term “qualified disaster mitigation payment” means any amount which is paid pursuant to the Robert T. Stafford Disaster Relief and Emergency Assistance Act (as in effect on the date of the enactment of this subsection) or the National Flood Insurance Act (as in effect on such date) to or for the benefit of the owner of any property for hazard mitigation with respect to such property. Such term shall not include any amount received for the sale or disposition of any property.
(3) No increase in basis
Notwithstanding any other provision of this subtitle, no increase in the basis or adjusted basis of any property shall result from any amount excluded under this subsection with respect to such property.
(h) Denial of double benefit
Notwithstanding any other provision of this subtitle, no deduction or credit shall be allowed (to the person for whose benefit a qualified disaster relief payment or qualified disaster mitigation payment is made) for, or by reason of, any expenditure to the extent of the amount excluded under this section with respect to such expenditure.
Casualty Loss Deductions And Delayed Deadlines
Much has already been written about the ability to extend the filing of tax returns and estimated payments. Robert Wood wrote an excellent post on this.
The IRS FAQ page on disaster victims does a great job of summarizing the casualty loss rules, which is something that CPA’s and financial advisors will learn lot about in the next few days and weeks.
I thought that readers might want to print the below IRS Q&A’s out instead of having to click 36 times to read this on screen, so they are replicated below for your convenience. You need not consider the environment before printing these so that you can take notes and mark up the pages to retain and work with this information. The alligators in Florida won’t mind.
Q1: Does disaster relief apply to me if my tax preparer is in a disaster area but I am not?[2]
A: Disaster relief applies to the clients of tax preparers who are unable to file returns or make payments on behalf of the client because of a federally declared disaster. Therefore, if you are a taxpayer outside of the disaster area, you may qualify for relief if:
• Your preparer is in the federally declared disaster area, and
• The preparer is unable to file or pay on your behalf.
To get the postponement for filing or payment, you must:
• Call the Disaster Hotline at 866-562-5227
• Explain your necessary records are located in a covered disaster area
• Provide the FEMA Disaster Number of the area where your tax preparer is located.
Q2:I own an interest in a partnership, or I am a shareholder in an S Corporation, located in a federally declared disaster area. However, I do not live in the disaster area myself. I rely on information (Schedule K-1)from the partnership or S Corporation to file my tax return. Do I qualify as an affected taxpayer for purposes of receiving filing and payment relief?
A: Yes. If the affected partnership or S Corporation cannot provide you the records necessary to file your return, then you are an affected taxpayer. Your filing and payment deadlines are postponed until the end of the postponement period just like the affected partnership or S Corporation.
To get the postponement for filing or payment, you must:
• Call the Disaster Hotline at 866-562-5227.
• Explain your necessary records are located in a covered disaster area.
• Provide the FEMA Disaster Number of the county where the affected partnership or S Corp is located.
• See Treas. Reg. § 301.7508A-1 and Rev. Proc. 2018-58 for a list of taxpayer acts that may be postponed in response to a federally declared disaster.
Tax Returns
Change of Address
Q1: What address should be used on a taxpayer’s return considering the number of times they may move and may not remain at a current address fora long period of time?
A: Taxpayers should use their current address when filing. If the taxpayer moves after filing the return, they should update their address with the IRS by calling the IRS Disaster Hotline at 866-562-5227, or by filing Form 8822, Change of Address. The IRS also recommends that taxpayers notify the Post Office serving the old address.
Amended Returns
Q1: If I sustain a loss that is attributable to a federally declared disaster, may I elect to deduct that disaster loss in the preceding tax year?
A: Generally, you may elect to deduct a disaster loss in the year you sustain the loss. This is known as the disaster year.
The disaster year is generally the year in which the disaster occurred but may be a year after the disaster occurred. If, for example, you have a claim for reimbursement with a reasonable prospect of recovery, then you have not sustained a loss until you know with reasonable certainty whether you will receive reimbursement.
If you have a loss attributable to a federally declared disaster occurring in an area identified by FEMA as qualifying for public or individual assistance (or both), you may elect to deduct that loss on your return or amended return for the tax year immediately preceding the disaster year. If you make this election, the loss is treated as having occurred in the preceding year.
This election may be made on Form 4684 Casualties and Thefts, section D. This election should be attached to a return or amended return for the preceding year. With respect to the due date for the election, you must make the election to claim your disaster loss in the preceding year on or before the date that is 6 months after the regular due date for filing your original return (without extensions) for the disaster year. See Publication 547 for more information.
A list of areas warranting public or individual assistance (or both) is available at the FEMA website at FEMA.gov/Disasters.
For tax years 2018 through 2025, if you are an individual, casualty or theft losses of personal-use property, are deductible only if the loss is attributable to a federally declared disaster.
Q2: How long does it take for the IRS to process amended returns filed by disaster victims who elect to deduct their disaster related loss in the preceding taxable year?
A: The IRS expedites processing of amended returns notated with the appropriate disaster information, on the top of page one of Form 1040X, i.e. “Midwestern Disaster Area.” The time frame is generally 60 days.
Q3: A taxpayer affected by a disaster timely filed a federal income tax return for the taxable year the disaster occurred and did not claim a casualty loss deduction on the return. May the taxpayer wait until a later year and amend the original return to claim a casualty loss deduction reduced by insurance and other reimbursements received in subsequent years?
A: A taxpayer may claim a casualty loss deduction for the first time on an amended original return. A casualty loss must be reduced by the amount of insurance proceeds and other reimbursements received.
Q4: A taxpayer affected by a disaster timely filed a federal income tax return for the taxable year the disaster occurred and claimed a casualty loss deduction. Taxpayer received reimbursements for the loss in a subsequent year. May a taxpayer file an amended return for the year in which the taxpayer claimed a casualty loss deduction to reduce the loss by the amount of the reimbursement the taxpayer received?
A: If a taxpayer properly claimed a casualty loss deduction on an original return and in a later year receives reimbursement for the loss, the taxpayer does not amend the original return. Instead, the taxpayer should report the amount of the reimbursement in gross income in the tax year in which the reimbursements were received, to the extent the casualty loss deduction reduced their income tax in the tax year that the taxpayer reported the casualty loss deduction. See section entitled “Insurance and Other Reimbursements” of Publication 547, Casualties, Disasters, and Thefts.
In computing the “tax benefit,” you are advised to review Publication 525, Taxable and Nontaxable Income.
Copies of Tax Returns
Q1: How does a taxpayer or return preparer obtain an expedited copy of a tax return or tax return transcript?
A: Copies of tax returns – You can use Form 4506, Request for Copy of Tax Return to order a copy of your tax return. Generally, there is a $50 fee for requesting each copy of a tax return. If your main home, principal place of business, or tax records are located in a federally declared disaster area, the fee will be waived if the name of the disaster (for example, “Midwestern Disaster Area”) is written across the top of the Form 4506, Request for Copy of Tax Return when filed.
Transcript of tax returns – The IRS will provide disaster victims or their return preparer with an expedited tax return transcript free of charge. Expedited services are available to taxpayers or their authorized representative who call the IRS Disaster Hotline at 866-562-5227. Also, Form 4506-T, Request for Transcript of Tax Return, may be faxed or mailed to the appropriate IRS Campus found in the instructions. If mailed, the appropriate disaster information, such as “Midwestern Disaster Area,” should be written across the top of the form. For tax professionals who are registered for E-Services, this is the most expedient and efficient method for obtaining the tax return transcript for their client.
Q2: What is the effect of filing an extension of time to file under section 6081,if, prior to the March 15, 202X, due date for filing a U.S. Return of Partnership Income (Form 1065), an event in the state and county in which the partnership was formed, results in the area being declared a federally declared disaster area and, pursuant to section 7508A of the Internal Revenue Code, the IRS postpones filing and payment obligations for the period March1, 202X, through June 30, 202X?
A: The partnership return must be filed by the later of the extended due date or the end of the postponement period. If the partnership, which is an affected taxpayer with respect to the federally declared disaster, filed an extension of time to file prior to the end of the postponement period (June 30, 202X), the extension would relate back to the due date, March 15, 202X. The extension would run from March 15, 2021, to September 15, 202X. Because the extended due date (September 15, 202X) is later than the end of the postponement period (June 30, 202X), the partnership’s Form 1065 is timely if filed on or before September 15, 202X.
Q3: A corporate taxpayer whose U.S. Corporation Income Tax Return (Form1120) is due to be filed on or before April 15, 202X, files an extension of time to file under section 6081 prior to the due date for filing the return thereby extending the due date to October 15, 202X. If, as a result of a disaster, the county in which the corporate taxpayer’s principal place of business is located is declared a federally declared disaster and pursuant to section 7508A of the Internal Revenue Code, the IRS postpones filing and payment obligations for the period May 1, 202X, through August 31, 202X, when must the corporate taxpayer file its Form 1120?
A: The postponement period under section 7508A runs concurrently with any extensions of time to file and pay under other sections of the Internal Revenue Code. The return must be filed by the later of the extended due date or the end of the postponement period. If the extended due date occurs prior to the end of the postponement period, the return must be filed by the end of the postponement period. If, however, the postponement period ends prior to the extended due date, the return must be filed by the extended due date. Here, the extended due date (October 15, 202X) is later than the end of the postponement period (August 31, 202X). Therefore, the corporate taxpayer’s Form 1120 must be filed by October 15, 202X. Unless the corporate taxpayer also filed and received an extension of time to pay pursuant to section 6161, the corporate taxpayer must pay any tax it owes by August 31, 202X, the last day of the postponement period.
Filing of Extensions/Extensions of Time to File
Q1: A taxpayer whose individual income tax return (Form 1040 or 1040-SR) is due to be filed on or before April 15, 202X, timely files an extension of time to file the return under section 6081 thereby extending the due date to October15, 202X. If the county in which the taxpayer resides is declared a federally declared disaster area and, pursuant to section 7508A of the Internal Revenue Code, the IRS postpones filing and payment obligations for the period September 1, 202X through December 31, 202X, when must the taxpayer file their Form 1040 or 1040-SR?
A: The taxpayer must file their individual income tax return by the later of the end of the postponement period or the extended due date. Here, the postponement period ends on December 31, 202X, which is later than the extended due date (October 15, 202X). Therefore, the taxpayer’s individual income tax return must be filed by December 31, 202X.
Q2: What is the effect of filing an extension of time to file under section 6081, if, prior to the March 15, 202X, due date for filing a U.S. Return of Partnership Income (Form 1065), an event in the state and county in which the partnership was formed, results in the area being declared a federally declared disaster area and, pursuant to section 7508A of the Internal Revenue Code, the IRS postpones filing and payment obligations for the period March1, 202X, through June 30, 202X?
A. The partnership return must be filed by the later of the extended due date or the end of the postponement period. If the partnership, which is an affected taxpayer with respect to the federally declared disaster, filed an extension of time to file prior to the end of the postponement period (June 30, 202X), the extension would relate back to the due date, March 15, 202X. The extension would run from March 15, 2021, to September 15, 202X. Because the extended due date (September 15, 202X) is later than the end of the postponement period (June 30, 202X), the partnership’s Form 1065 is timely if filed on or before September 15, 202X.
Q3: A corporate taxpayer whose U.S. Corporation Income Tax Return (Form1120) is due to be filed on or before April 15 ,202X, files an extension of time to file under section 6081 prior to the due date for filing the return thereby extending the due date to October 15, 202X. If, as a result of a disaster, the county in which the corporate taxpayer’s principal place of business is located is declared a federally declared disaster and pursuant to section 7508A of the Internal Revenue Code, the IRS postpones filing and payment obligations for the period May 1, 202X, through August 31, 202X, when must the corporate taxpayer file its Form 1120?
A: The postponement period under section 7508A runs concurrently with any extensions of time to file and pay under other sections of the Internal Revenue Code. The return must be filed by the later of the extended due date or the end of the postponement period. If the extended due date occurs prior to the end of the postponement period, the return must be filed by the end of the postponement period. If, however, the postponement period ends prior to the extended due date, the return must be filed by the extended due date. Here, the extended due date (October 15, 202X) is later than the end of the postponement period (August 31, 202X). Therefore, the corporate taxpayer’s Form 1120 must be filed by October 15, 202X. Unless the corporate taxpayer also filed and received an extension of time to pay pursuant to section 6161, the corporate taxpayer must pay any tax it owes by August 31, 202X, the last day of the postponement period.
Payments
Penalty and Interest
Q1: Is there any interest relief for taxpayers who have balances due that arise during the disaster relief period for prior year returns?
A: No. The IRS will not abate interest on balances due on liabilities for prior years. However, the IRS will consider waiving late payment penalties when the reason for the late payment is due to reasonable cause related to the disaster.
Q2: What, if any, relief is accorded to Installment agreement payments that become due during the disaster relief period?
A: Installment agreement payments due during the disaster relief period are suspended. After the postponement period has ended, the installment agreement will be reinstated (without a fee). The taxpayer will be required to resume making payments in accordance with the terms of the installment agreement beginning the month that follows after the end of the postponement period.
Mitigation Payments
Q1: Are mitigation payments under Code section 139 tax-free?
A: Qualified disaster mitigation payments are excludable from the recipient’s income. Such payments are amounts paid under the Robert T. Stafford Disaster Relief and Emergency Assistance Act or the National Flood Insurance Act (as in effect on April 15, 2005) to or for the benefit of the owner of any property for hazard mitigation. There is no resulting increase in the basis or adjusted basis of the property for which the payments are made. Also, no person for whose benefit a qualified disaster mitigation payment is made can take a deduction or credit due to an expenditure for which exclusion for a payment is granted. The exclusion does not apply to amounts received for the sale or disposition of property.
Q2: Do you have to subtract FEMA payments in arriving at the calculation for your net casualty loss?
A: According to Publication 547, in the section entitled “Types of Reimbursements,” food, medical supplies, and other forms of assistance you receive do not reduce your casualty loss, unless they are replacements for lost or destroyed property. In calculating your casualty loss, if the payment is for replacement of lost or destroyed property, then you would subtract the amount in figuring your casualty loss.
Taxable State Recovery Payments
Q1: How do reimbursements from state funds to compensate for property damage that are received in a subsequent year affect a homeowner’s casualty loss and basis computations?
A: If a taxpayer properly claimed a casualty loss deduction and in a later year receives reimbursement for the loss, the taxpayer reports the amount of the reimbursement in gross income in the tax year it is received to the extent the casualty loss deduction reduced the taxpayer’s income tax in the year in which the taxpayer reported the casualty loss deduction. If the subsequent year reimbursement exceeds the amount of the casualty loss deduction, the taxpayer reduces basis in the property by the amount of such excess. In addition, the taxpayer includes such excess in income as gain to the extent it exceeds the remaining basis in the property, unless such gain can be excluded from income or its recognition can be deferred. Also see section entitled “Insurance and Other Reimbursements” of Publication 547, Casualties, Disasters, and Thefts.
Q2: What if a net operating loss (NOL) was generated on the original return, would a taxpayer amend all amended returns and Form 1045?
A: No. If a taxpayer properly claimed a casualty loss deduction and in a later year receives reimbursement for the loss, the taxpayer reports the amount of the reimbursement in gross income in the tax year it is received to the extent the casualty loss deduction reduced the taxpayer’s income tax in the tax year in which the taxpayer reported the casualty loss deduction or reduced income tax in a prior year as a result of an NOL caused by a casualty loss deduction. See the preceding question for guidance if the subsequent year reimbursement exceeds the amount of the casualty loss deduction. Also see section entitled “Insurance and Other Reimbursements” of Publication 547, Casualties, Disasters, and Thefts.
In computing the “tax benefit,” you are advised to review Publication 525, Taxable and Nontaxable Income.
Property and Casualty Loss
Casualty Loss (Valuations and Sections 165 (i))
Q1: A number of concerns have been raised by taxpayers and tax professionals about casualty loss valuations. Will the IRS continue to research and develop specific answers to these issues?
A: While we cannot address every question received about property valuation issues, the IRS wants to express to the public that we recognize the extraordinary damage disasters can cause. We urge taxpayers and tax professionals to act in good faith and make reasonable estimations based on all information available. The IRS considers each situation on a case-by-case basis. We have extensive experience with disaster situations and will be reasonable in determinations.
As for lost records, when records are not available or it is not feasible to obtain documentation sufficient to re-create records otherwise required, the IRS will consider documentation requirements satisfied by the best reasonably available information presented in good faith.
Q2: What is the best method of reporting casualty losses on Form 4684 when using the repairs as evidence of the loss?
A: Under the law, a personal casualty loss is determined by taking the smaller of:
The cost or other basis of the property (reduced by any insurance reimbursement), or
The decline in fair market value of the property as measured immediately before and after the casualty (reduced by any insurance reimbursement).
The cost of repairs may, in certain cases, be used to measure the decline in fair market value, but it cannot be used by itself to determine the amount of the loss. The cost to repair method may be used if the repairs are actually made, are not excessive in cost, are necessary to bring the property back to its condition before the casualty, take care of the damage only, and do not cause the property to be worth more than before the casualty. See Regulations § 1.165-7(a)(2). When the cost of repairs is determined to be a fair measure of the decline in fair market value, then all you have to do is take the fair market value before the casualty and reduce it by the cost of repairs to arrive at the fair market value after the casualty. See section entitled “Decrease in Fair Market Value” of Publication 547, Casualties, Disasters, and Thefts.
For tax years 2018 through 2025, if you are an individual, casualty or theft losses of personal-use property are deductible only if the loss is attributable to a federally declared disaster.
Suggestions for redesign of the Form 4684 to make the computation less cumbersome and still follow the law are welcome and may be submitted at the Comments on Tax Forms and Publications page, or you may write to Internal Revenue Service, Tax Forms and Publications Division, 1111 Constitution Ave. NW, IR-6526, Washington, DC 20224.
Q3: The decrease in fair market value of the property for which I am taking a casualty loss is the difference between the property’s value immediately before and immediately after the casualty. What constitutes “immediately after”?
after the casualty. What constitutes “immediately after”?
A: To compute the amount deductible as a casualty loss, taxpayers need to determine: (1) the difference between the fair market value immediately before and immediately after the casualty; and (2) the adjusted basis of the property (usually the cost of the property and improvements). Taxpayers may deduct the smaller of these two amounts minus insurance or any other form of compensation received or expected to be received.
One method of determining the decrease in fair market value is an appraisal. An appraisal must reflect only the physical damage to the property and not a general decline in the property’s fair market value. Taxpayers may also use the cost to repair or clean up the property (cost-of-repairs method) to determine the decrease in fair market value caused by the casualty. See section entitled “Decrease in Fair Market Value” of Publication 547, Casualties, Disasters, and Thefts.
Although we use the term “immediately after” when referring to the post-casualty value, we recognize that taxpayers’ ability to determine the decrease in the fair market values of their properties, as a result of a disaster, may be restricted by lack of access to the properties. For example, if taxpayer’s property flooded and access to the property was restricted until all the water was removed from the area, the decrease in fair market value would take into account any additional damage sustained to the property as a result of delays due to legal and physical restrictions to taxpayers’ access to their property.
For tax years 2018 through 2025, if you are an individual, casualty or theft losses of personal-use property are deductible only if the loss is attributable to a federally declared disaster.
Q4: If a taxpayer owns several parcels of real estate that are damaged by a federally declared disaster, may the taxpayer choose to claim a casualty loss on one property in the preceding year and a casualty loss on other property in the disaster year?
A: No. If a taxpayer chooses to deduct a disaster loss sustained in the disaster year on an original or on an amended return for the preceding year, the taxpayer must report all related losses that qualify for the election on the preceding year return. See § 1.165-11(c) of the Income Tax Regulations.
Q5: A homeowners/condo association sustained a loss from a disaster and made a special assessment on owners to replace uninsured property. May the homeowners claim the special assessment as a casualty loss?
A: The answer depends on whether the damaged property was owned by the homeowners association or by the individual members as tenants in common.
A homeowner’s association (including a condominium association) is organized and operated for the purpose of acquiring, constructing, managing, and maintaining “association property.” Such property includes real and personal property owned by the organization or owned as tenants in common by the members of the organization. This property is generally referred to as “common elements.”
Funds for performance of the activities of the homeowners association are generally derived from assessments of the members and the assessments include real property taxes on association property as well as reserves for capital items such as resurfacing a parking lot, replacement of street lights, construction of a swimming pool, etc. This would include special assessments for any uninsured portion of the cost of repair or replacement of property damaged by a natural disaster.
A casualty loss deduction is only allowed for losses from property owned by the taxpayer. If the common elements are not owned by individual members, but rather by the homeowner’s association, an individual member would not be entitled to a casualty loss deduction. A member’s assessment for the replacement of a capital item, whether or not the item was damaged by a casualty, is in the nature of a contribution to the capital of the homeowners association and is not currently deductible by the member.
However, if the individual members of the homeowners association own the common elements as tenants in common, the individual members may be entitled to casualty loss deductions in proportion to each member’s interest in the damaged common elements.
To compute the amount of a casualty loss, a taxpayer must determine the fair market value of the property both immediately before and immediately after the casualty and compare the decrease in fair market value with the adjusted basis in the property. From the smaller of these two amounts, a taxpayer must subtract any insurance or other form of compensation they have received or reasonably expect to receive. Fair market value may be determined by an appraisal. The cost to repair or clean up the property (cost-of-repairs method) may also be used as a measure of the decrease in fair market value caused by the casualty if the repairs are actually made, are not excessive in cost, are necessary to bring the property back to its condition before the casualty, take care of the damage only, and do not cause the property to be worth more than before the casualty. See Regulations § 1.165-7(a)(2).
If the members own the common elements damaged by the casualty as tenants in common, they are entitled to a casualty loss deduction for the lesser of: (1) the decline in value of their ownership interest as a result of the casualty or (2) their adjusted basis. From the smaller amount, the member should subtract any insurance or other form of compensation received or expected to be received. With respect to a member claiming the special assessment as a casualty loss, a member could use the amount of the assessment as a measure of the decrease in the fair market value of the common elements caused by the casualty as long as the amount of the assessment is commensurate with the member’s ownership interest in the common elements and the requirements for using the cost-of-repairs method of valuation, described above, are satisfied.
In summary, if the common elements are owned by the homeowners association, the members are not entitled to any casualty loss deduction for damage to the common elements and, therefore, the members may not deduct a special assessment to replace uninsured property (common elements) damaged by a disaster. However, if the common elements are owned by the members of the homeowner’s association as tenants in common, the members may be entitled to a casualty loss deduction as discussed above.
Please note that for tax years 2018 through 2025, if you are an individual, casualty or theft losses of personal-use property are deductible only if the loss is attributable to a federally declared disaster.
Q6: How does a taxpayer determine a casualty loss from damaged trees and other landscaping on personal-use residential property when that loss is attributable to a disaster?
A: In determining the amount of a casualty loss from damage to personal-use residential real property, trees and other landscaping are considered part of the entire residential property, and are not valued separately or assigned a separate basis, even if purchased separately. However, taxpayers should note that loss of property due to progressive deterioration is not deductible as a casualty loss. This is because the damage results from a steadily operating cause or a normal process, rather than from a sudden event.
For tax years 2018 through 2025, if you are an individual, casualty or theft losses of personal-use property are deductible only if the loss is attributable to a federally declared disaster.
To compute your casualty loss:
Determine your adjusted basis in the entire residential property before the casualty. Your basis is generally the cost of the property, adjusted for improvements and certain other events. For more information on determining your adjusted basis, see Publication 530, Tax information for Homeowners, and Publication 551, Basis of Assets.
Determine the decrease in fair market value of the entire residential property as a result of the casualty.
From the smaller of these two amounts, subtract insurance and any other form of compensation received or expected to be received.
For residential property, damaged and destroyed trees and other landscaping may adversely affect the fair market value of the entire property by reducing the curb or overall appeal of the property.
One method of determining the decrease in fair market value is to compare an appraisal of the entire residential property, including trees and other landscaping, before the damage caused by the casualty, to an appraisal of the entire residential property after the damage caused by the casualty, including damage to trees and other landscaping. Valuation of the damage to a tree by an arborist does not determine the decrease in fair market value of the entire property.
Alternatively, the cost of cleaning up and restoring the residential property, including trees and other landscaping, to its condition before the casualty may be used as evidence of the decrease in fair market value, if the clean-up, repairs, and restoration are actually done, are not excessive in cost, are necessary to bring the property back to its condition before the casualty, take care of the damage only, and do not cause the property to be worth more than before the casualty. For example, if these requirements are satisfied, the cost of removing destroyed or damaged trees (minus any salvage received), pruning and other measures taken to preserve damaged trees, and replanting necessary to restore the property to its approximate value before the casualty may be acceptable as evidence of the decrease in fair market value caused by the casualty. You may not include in your cost of cleaning up and restoring your property the cost of purchasing any capital asset, such as a compact loader or tractor, or the value of the time you spend cleaning up your own property.
The following examples illustrate the points discussed above:
Example 1: A taxpayer lost a large tree in her backyard due to a disaster but sustained no other property damage. An arborist valued the damage to the tree at $3,000. The taxpayer spent $600 to remove the tree from the yard and grind the stump. Insurance paid $500 for debris removal.
The value of the damage to the tree determined by the arborist does not qualify as a measure of the casualty loss because it does not reflect the decrease in the fair market value of the residential property as a whole, including the residence, land, and improvements. The taxpayer may obtain an appraisal of the entire property to determine any decrease in value resulting from the loss of the tree.
Alternatively, the taxpayer may use costs incurred to clean up and to remove the tree as a measure of the decrease in the fair market value of the property provided the costs are not excessive, are necessary to bring the property back to its condition before the casualty, take care of the damage only, and do not cause the property to be worth more than before the casualty. The taxpayer would subtract from the loss any insurance reimbursement for tree removal and clean-up expenses. Under this alternative, the taxpayer has a casualty loss of $100.
If, however, the personal casualty loss occurred any time beginning after December 31, 2017 and ending before January 1, 2026, the loss is only allowed to the extent that the disaster which caused the loss was a Federally declared disaster.
Example 2: A taxpayer had a large tree that fell during a disaster and crushed a carport. Among many trees on the property, it was the only tree that was damaged. The loss of this tree does not affect the fair market value of the entire property. Homeowners’ insurance reimbursed the taxpayer all costs for repairing the carport and removing the tree.
Insurance paid for all repair costs to bring the property back to its pre-casualty condition and value. Therefore, the taxpayer has no casualty loss.
For more information on casualty losses, see Publication 547, Casualties, Disasters & Thefts.
Q7: How will the IRS handle water damage and “mold issues” because of insufficient repairs or other events. Will there be special reporting on the loss related to mold?
A: Whether individuals may claim damage to their personal-use property from mold as part of a casualty loss depends on the facts and circumstances of each situation. A key factor to consider is whether the mold damage occurred as a direct result of the disaster or from some other intervening cause since there must be a causal connection between the casualty event and the loss claimed by the taxpayer. For example, individuals would not be entitled to deduct, as part of their casualty loss, mold damage that occurred because of insufficient repairs. The individuals’ casualty loss deduction would be limited to the property damage caused by the disaster. In addition, if a large amount of time elapsed between the date of the disaster and the formation of the mold, this raises the question of whether the mold damage was caused by the disaster or by some other factor.
The formation of mold may qualify as a separate casualty. A casualty is an event that is identifiable, damaging to property, sudden, unexpected, and unusual in nature. An event is sudden if it is swift, precipitous, not gradual, or due to progressive deterioration of property through a steadily operating cause. An event is unexpected if it is unanticipated and it occurs without the intent of the one who suffers the loss. An event is unusual if it is extraordinary, nonrecurring, one that does not commonly occur during the activity in which the taxpayer was engaged when the destruction or damage occurred, and does not commonly occur in the ordinary course of day-to-day living of the taxpayer. If, under a particular set of facts, the formation of mold is a sudden, unexpected, unusual and identifiable event that caused damage to the individual’s property, then it would qualify as a casualty and the individual may be entitled to deduct the loss for the resulting property damage as a casualty loss under section 165(c)(3) if the individual satisfies the other requirements for the deduction.
Please note that for tax years 2018 through 2025, if you are an individual, casualty or theft losses of personal-use property are deductible only if the loss is attributable to a federally declared disaster.
Q8: A business building has an adjusted basis of $40,000 ($30,000 building and$10,000 land) and the building is 50% destroyed by a federally declared disaster. Insurance proceeds of $10,000 for the damage (not for living expenses). Cost to repair is $85,000. What is the amount of the taxpayer’s casualty loss deduction?
A: If the business property was damaged but not totally destroyed, the casualty loss is measured by the lesser of the adjusted basis or the decrease in fair market value, minus any other form of compensation (such as insurance reimbursement). There are two methods for taxpayers to determine the decrease in fair market value of property affected by a casualty. The first method is an appraisal. An appraisal must reflect only the physical damage to the property and not a general decline in the property’s fair market value. The second method is the cost to repair the property. The cost to repair the damaged property may be used as evidence of the decrease in value if the taxpayer makes the repairs and shows that the repairs: (a) are necessary to bring the property back to its condition before the casualty; (b) the amount spent for repairs is not excessive; (c) the repairs take care of the damage only; and, (d) the value of the property after the repairs is not, as a result of the repairs, more than the value of the property before the casualty. See Publication 547, Casualties, Disasters, and Thefts.
Since the property is used in a trade or business, the casualty loss deduction must be computed based on each single identifiable property. Therefore, the taxpayer must compute the loss deduction with respect to the building separately. If the taxpayer satisfies all of the requirements for the cost of repairs method, then the casualty loss would be measured by comparing the decrease in fair market value (as evidenced by the cost of repairs) to the adjusted basis of the building. The casualty loss with respect to the building would be the lesser of the decrease in fair market value of the building or the adjusted basis of the building, reduced by insurance compensation. The deductible casualty loss for the building would be $20,000, computed by using $30,000, which is the lesser of the decrease in fair market value of the building ($85,000) (we are assuming that the $85,000 reflects only the cost to repair the building) or the adjusted basis of the building ($30,000) and subtracting from $30,000 the insurance payment of $10,000 (assuming that the $10,000 insurance compensation covered the loss of the building only).
The casualty loss must be computed separately for any other improvements to the property.
What is the taxpayer’s basis in the building?
Response: The taxpayer’s basis in the damaged building is reduced by the amount of the insurance proceeds received and the amount of the allowable casualty loss deduction attributable to the damaged building.
If the taxpayer repairs the partially destroyed building, how do the repair costs affect the computation of the taxpayer’s basis in the building?
Response: If the taxpayer repairs the damaged building, the cost of the repairs ordinarily is capitalized and added to the taxpayer’s tax basis in the damaged building.
What is the authority for the basis information described above?
Response: Sections 1012 and 1016 of the Internal Revenue Code. Section 1012 provides, generally, that the basis of property is its cost to the taxpayer. Section 1016 requires that proper adjustment be made to the basis of property for expenses, receipts, losses, or other items properly chargeable to capital account.
Q9: Is there an audit technique guide to assist in the preparation of casualty Losses?
A: No, but there is other IRS-issued guidance to help taxpayers determine and report disaster-related casualty losses. See Publication 584, Casualty, Disaster and Theft Loss Workbook. Also see, Internal Revenue Manual Section 4.10.7.3, Evaluating Evidence, and Section 4.10.7.4, Arriving at Conclusions.
Q11: The cost of making repairs to restore property to its original condition can be used as a measure of the decrease in the fair market value of the property. If the repairs have not yet been made but the taxpayer received an estimated cost of the repairs, can the taxpayer report the estimated cost on the taxpayer’s return?
A: No. To be able to use the cost of repairs method to determine the decrease in fair market value of a property, the repairs must have been made by the due date of the tax return. If the repairs have not been made, the taxpayer should file the return without reporting the casualty loss information. After the repairs have been made, the taxpayer may file an amended return.
Q12: Previously, taxpayers affected by a federally declared disaster were instructed to write, in red ink, at the top of the Form 1040 or 1040-SR, information that identifies the particular disaster. Because many taxpayers file their returns electronically, how will they receive the designated disaster tax relief?
A: Original electronic or paper returns do not require the disaster designation. When the Federal Emergency Management Agency (FEMA) notifies the IRS of the areas qualifying for Individual Assistance under a federal disaster declaration the IRS systemically codes taxpayer accounts if the taxpayer’s address of record reflects a zip code within the affected counties. The disaster indicator will identify the account as being eligible for applicable tax filing or payment relief.
Affected taxpayers filing an amended return (Form 1040X), to claim disaster casualty losses, may still place the designation at the top of the form. This action assists in processing disaster claims expeditiously.
Q13: During a recent disaster many taxpayers lost food stored in refrigerator sand freezers due to long periods without electricity. Multiple insurance companies reimbursed policyholders a flat amount for food losses, without requiring the policyholders to itemize the food losses or file claims. If the amount the taxpayer received from the insurance company exceeded the original cost of the food, does the taxpayer have a reportable gain?
A: No. Section 1033(h)(1)(A)(i) of the Code states that no gain shall be recognized by reason of the receipt of any insurance proceeds for personal property which was part of such contents and which was not scheduled property for purposes of such insurance.
Q14: May taxpayers use the value of their property, as stated in their most recent property tax statement, to establish the FMV of the property before the casualty?
A: No. The law allows the taxpayer to establish the FMV of the property before the casualty by either: (1) obtaining an appraisal from a competent appraiser; or (2) by using the cost of repairs method. See Publication 547, Casualties, Disasters, and Thefts. The IRS will review each return based on the particular facts and circumstances.
SBA Loan
Q1: If a taxpayer secures a low-interest disaster loan from the Small Business Administration, what effect will it have on calculating a casualty loss?
A: A low-interest disaster loan from the Small Business Administration must be repaid and therefore does not reduce the casualty loss amount. However, any amounts of the loan which are cancelled or forgiven are included in gross income in the year of cancellation. Additionally, insurance proceeds or other reimbursements received (or claims for reimbursement for which there is a reasonable prospect of recovery), and not required to be repaid, will reduce the casualty loss.
Generally, to figure the amount of your casualty and theft losses, you must determine the actual reduction in the FMV of lost or damaged property using a competent appraisal or the cost of repairs you actually make. Revenue Procedure 2018-08, 2018-2 I.R.B. 286, provides safe harbor methods that you may use to determine the amount of your casualty and theft losses. Under the disaster loan appraisal safe harbor method, you may use an appraisal prepared to obtain a loan of federal funds or a loan guarantee from the federal government that identifies your estimated loss from a federally declared disaster to determine the decrease in the fair market value of your personal use residential real property. See section entitled “Figuring a Loss” of Publication 547, Casualties, Disasters, and Thefts and Revenue Procedure 2018-08, 2018-2 I.R.B. 286. The use of the special safe harbor method of the revenue procedure is not mandatory. For tax years 2018 through 2025, if you are an individual, casualty or theft losses of personal-use property are deductible only if the loss is attributable to a federally declared disaster.
Sale of Home
Q1: If a taxpayer’s main home was destroyed by a federally declared disaster and the taxpayer later sells the vacant land used only in conjunction with the main home, will gain from the sale of the vacant land qualify for exclusion under § 121 of the Code?
A: The destruction of a taxpayer’s home is treated as a sale of the home and any gain may qualify for the exclusion under § 121 of the Internal Revenue Code. Generally, a sale of vacant land that does not include a dwelling structure does not qualify as a sale of a taxpayer’s home. However, if the vacant land was owned and used by the taxpayer as part of the taxpayer’s main home and the sale of the vacant land occurs within two years from the sale of the main home, the sale of the vacant land and the sale of the taxpayer’s main home will be treated as one sale and the § 121 exclusion will apply to that sale if the taxpayer otherwise meets the requirements of § 121. See § 1.121-1(b)(3) of the Income Tax Regulations. See Publication 523, Selling Your Home.
For example, if a taxpayer’s main home was destroyed, the taxpayer may exclude gain up to the limitation amount of $250,000 ($500,000 for certain situations involving joint returns) if the taxpayer otherwise meets the requirements of § 121 of the Code. If the taxpayer later sells the vacant land used in conjunction with the main home within two years from the date of its destruction, the taxpayer is eligible to use any unused portion of the § 121 limitation amount to exclude gain from the sale of the vacant land.
Realized Gain on Main Home
Q1: What are the rules for taxpayers who realize gain from receipt of insurance proceeds or other reimbursements for damage or destruction of amain home that is in a federally declared disaster area?
A: If the taxpayer’s main home is damaged, a taxpayer may elect to postpone recognizing gain under the involuntary conversion rules by investing in property similar or related in service or use to the damaged property and meeting other requirements. Generally, the taxpayer must replace the damaged property within two years after the close of the taxable year in which the gain is realized. However, if the damaged property is in a federally declared disaster area, the replacement period is four years.
If the taxpayer’s main home is destroyed, the destruction may be treated as a sale for purposes of the tax provisions governing the exclusion of gain from the sale of a principal residence. If certain conditions are met, the gain may be excluded up to $250,000 ($500,000 for certain situations involving joint returns). If the destruction exceeds the $250,000/ $500,000 limitation, the excess gain may be deferred under the involuntary conversion rules.
Expenses
Travel Expenses
Q1: If your employer relocates to another location because of a federally declared disaster, how do you determine if you will be able to deduct your travel expenses?
A: For tax years beginning after December 31, 2017 and ending before January 1, 2026, travel expenses may only be deducted on Schedule C for taxpayers who own a business and not as a miscellaneous itemized deduction for taxpayers in the trade or business of being an employee. If this restriction does not apply, the answer will then depend on whether the employer move is realistically expected to be for less than or more than one year. A temporary assignment away from home, an assignment whose termination can be foreseen within a fixed and reasonably short period (less than one year), does not shift the “tax home.”
Therefore, a taxpayer may deduct the necessary traveling expenses in getting to his temporary assignment and also for the return trip to his tax home after the temporary assignment is completed, and his expenses for lodging and 50% of the cost of the meals while he is in the place to which he is temporarily assigned.
A taxpayer is not treated as being temporarily away from home if his period of employment exceeds one year (Code Sec. 162(a)). The one-year rule generally is not triggered by short intermittent assignments that span more than one year.
Employment away from home at a single location for a period of less than a year is treated as temporary, in the absence of facts and circumstances indicating otherwise. If employment away from home is a single location initially is realistically expected to last for one year or less, but later is realistically expected to exceed one year, then the employment will be treated as temporary until the date that the taxpayer’s realistic expectation changes (at which point the employment will no longer be “temporary”).
An indefinite assignment away from home shifts the “tax home” and the taxpayer cannot deduct expenses of travel, meals, and lodging while in the location of the “indefinite assignment.” Employment is indefinite if it lasts for more than one year, or there is no realistic expectation that the employment will last for one year or less.
Q2: May a taxpayer claim a travel expense deduction if the taxpayer is displaced by a federally declared disaster and must live and work in another locality?
A: The tax law generally allows business expense deductions for ordinary and necessary traveling expenses (including meals and lodging) incurred while away from home in pursuit of a trade or business. For tax years beginning after December 31, 2017 and ending before January 1, 2026, travel expenses may only be deducted on Schedule C for taxpayers who own a business and not as a miscellaneous itemized deduction for taxpayers in the trade or business of being an employee. A taxpayer’s “home” is generally the vicinity of the taxpayer’s principal place of business, as determined by all the facts and circumstances. However, if the taxpayer realistically expects to work in a single location for more than one year (or there is no realistic expectation that the work in the single location will last for one year or less), that location must be treated as the tax home (regardless of whether work actually exceeds a year).
Thus, if a displaced taxpayer lives and works in another locality, but realistically expects to return to live and work in the affected area within one year, the taxpayer may be considered to be traveling away from home in pursuit of a trade or business. If the displaced taxpayer works in more than one locality, however, the facts and circumstances must be considered to determine which locality is the taxpayer’s “home.”
Again, please send your questions that we can answer on Wednesday, October 5, 2022 at 4:00 PM EST to info@gassmanpa.com and you will receive an invite to the Webinar and a link to see replays as many times as you like.
Thanks to whoever in the IRS is working so quickly on this guidance and showing an active interest in the welfare of those who are subject to this terrible disaster.
More to Come
We will keep you posted as more information and planning techniques come to light. Readers are invited to share planning ideas and new information with me at agassman@gassmanpa.com
Thanks to Brittany Baker for working with me on Saturday to put this together after clearing the debris from the house she evacuated to and getting a car towed so that she could get her car out of the garage.