ELITE ADVISOR BEST PRACTICES

Tax Help for Clients Impacted by Natural Disasters

Advisors should ensure that clients make smart decisions about their properties when lives are unsettled

CEG’s Elite Advisor Report interview with Sidney Kess

Key Takeaways:

  • Clients who’ve recently lost their homes or suffered extensive property damage during the recent natural disasters may qualify for some help from the IRS.
  • Beyond deducting insurance and FEMA payments, some people who start calculating their losses will bump into rules about fair market value.
  • Experts say the value of a destroyed property is what it was worth just before the storm, not what it was worth when new or what it would cost to replace.

While there’s little nice to say about natural disasters, they don’t play favorites. They can hit anyone at any time, regardless of geography, ethnicity, income or tax bracket. And it can be an extremely stressful time for your clients no matter how well they think they’ve protected themselves.

Tax experts such as Sidney Kess, an accountant and lawyer at Kostelanetz & Fink in Manhattan, say that clients who have recently lost their homes or suffered extensive property damage during the recent wave of natural disasters in the United States may qualify for some help from the IRS. As you might expect, the tax code isn’t simple, and not everybody will qualify. Still, income tax deductions are available for some people who have major losses from a casualty, which the IRS defines as “the damage, destruction or loss of property from an identifiable event that is sudden, unexpected or unusual.”

However, as IRS Publication 584 notes, losses can be deducted only if they are more than 10 percent of your client’s adjusted gross income plus $100. In addition, the deduction applies only to uninsured losses. Any insurance payments for damaged or destroyed property have to be subtracted from the loss, which makes homeowners who did not have flood insurance more likely to be eligible.

Any payments that storm victims received from the Federal Emergency Management Agency for repairs to damaged or destroyed homes or their replacement must also be deducted from a casualty loss. Other FEMA payments, such as those for food and temporary housing, do not have to be deducted, he says.

Beyond deducting insurance and FEMA payments, some people who start calculating their losses will bump into rules on fair market value. Experts say the value of destroyed property is what it was worth just before the storm, not what it was worth when it was new or what it would cost to replace.

Kess gives an example of someone whose car, bought five years ago for $25,000, was submerged in salt water and destroyed and who received the $10,000 book value of that car from an insurance company. If a similar model new car was then bought for $30,000, that person may think “I took a beating,” Mr. Kess says. But there is no loss for tax purposes, he explains, because the person has recovered the fair market value of a five-year-old car.

Some property, though, doesn’t lose much value over the years. For instance, if waterlogged walls have to be replaced, the repair bill will most likely be the amount of the casualty loss, says Kess. “The cost of repairs to damaged property is acceptable as evidence of the value of the loss,” as long as the value of the repairs doesn’t increase the value of the property beyond its pre-storm value.

Even then, the loss is limited to the property’s original cost.

Business rules different

Different rules apply to business or investment property, Kess says. For one thing, there is no deduction of 10 percent of income. But any depreciation that has been claimed in previous years does enter the calculation.

While FEMA repair funds generally go only to primary residences, not to vacation homes or rental property, such property can be eligible for casualty losses if your client is the owner of the property. For taxpayers who legally qualify as property “owner,” the losses are not deducted from their income dollar for dollar. It depends on your client’s tax bracket. The loss also reduces state and any city income taxes, Kess added.

Some taxpayers may not yet know if they have a deductible casualty loss, because they are awaiting the resolution of insurance claims. One way to deal with that is to request an automatic six-month extension of the April 15 tax filing date, Kess says.

Another uncertainty is whether Congress will remove the requirement that a casualty loss be reduced by 10 percent of adjusted gross income, a step it took after Hurricane Katrina and some other devastating hurricanes. That uncertainty may be another reason to request an automatic extension.

Instead of deducting casualty losses on their 2012 returns, taxpayers can opt to use them to reduce 2011 income by filing an amended return, Kess says. That might benefit someone whose income dropped drastically in the last two months of last year because of the storm and to whom the deduction is thus more valuable against 2011 income, he says.

Conclusion

Having one’s property destroyed or severely damaged is extremely stressful for most homeowners. Advisors who take the time to understand the complex rules about reimbursement and compensation can prevent clients from making hasty and irrational decisions that they—and their heirs—could regret for years and years.


About the Author

Sidney Kess, CPA, J.D., LL.M., is of counsel to Kostelanetz & Fink LLP in New York City and is one of the nation’s most prominent lecturers on continuing professional education. Mr. Kess was recently selected “Most Influential Practitioner” by CPA Magazine and is a nationally renowned tax expert and author of hundreds of tax books about financial and estate planning.