Kevin Hines CPA

I have been getting a number of questions asking about food spoilage and whether these costs are eligible for a casualty loss deduction.  The simple answer is “Maybe”. 

 The replacement cost of the food can be deductible if not reimbursed by insurance. 

 Costs would be deductible once they a)exceed insurance proceeds, b) exceed $100 per event and c) exceed 10% of AGI ( adjusted gross income) for individual taxpayers.

I have been getting a number of questions asking about tree damage and whether these costs are eligible for a casualty loss deduction.  The simple answer is “Maybe”. 

The cost to clean up and remove damage would be deductible if not reimbursed by insurance. 

Replacement costs would be covered to bring the property back to its original state as long as the costs were not excessive. 

An alternative to this “Replacement Cost” approach would be to determine if the fair market value of the real estate in total was reduced.  This probably would require an a appraiser to review the property both before and after as well as document his opinion in order to pass muster with the IRS.

Costs would be deductible once they a)exceed insurance proceeds, b) exceed $100 per event and c) exceed 10% of AGI ( adjusted gross income) for individual taxpayers.

 Please keep the questions coming.

The significant damage caused by the recent Tornadoes of June 1^st to the Western Massachusetts community as well as Worcester County homeowners and businesses has generated numerous tax-related questions.  Property owners are asking if there is any economic relief by way of income tax deductions for the casualty losses that they have incurred.  The following is a generally discussion of the income tax rules regarding casualty loss deductions and possible taxable gains.  A review of the general rules is a useful launching point for you to review your own situation with your tax professional since each situation will be unique.

There are different rules for deducting damage losses if the loss is incurred on business property or nonbusiness (personal use) property.

Business Property

If the damage was caused to business property (i.e. income producing property), the loss is the smaller of the decrease in fair market value (FMV) caused by the casualty and the adjusted tax basis (investment less depreciation deducted over time).  The lower of the two numbers then must be reduced by insurance reimbursements.  This calculated value represents the casualty loss.  Other expenses such as clean-up costs and temporary replacement costs are not part of the casualty loss.  You may be able to consider these costs as other deductible business expenses but they are not part of the deduction for the loss.

In order to establish the amount of the loss, you may need to contact an appraiser (real estate, machinery/equipment appraiser or other qualified person) to determine the value both before and after the casualty loss in order to determine the decrease in FMV.  Documentation (pictures, reports, replacement costs) should be kept at least three years beyond the sale of the property to establish the loss and prove the adjusted tax basis of the investment.

All casualty gains and losses are to be netted in any calendar year.

Nonbusiness Property

Personal property losses follow similar loss rules as business property to determine the amount of the loss.  However, there are two additional hurdles to jump through in order to take the loss deduction.  The loss must exceed $100 and 10% of the taxpayers adjusted gross income.  By completing Federal form 4684, you can determine the amount of the deduction which then becomes one of your itemized deductions in the year of the loss.

The bottom line is that many taxpayers who suffered a loss may not have a tax deduction since the loss must exceed the reimbursement of insurance proceeds, $100 threshold and 10% of the taxpayers adjusted gross income.

Tax Deferral of Gain

A casualty event may result in a gain rather than a loss.  For business property, this often happens when insurance proceeds exceed the adjusted basis of the property lost.  If a net gain does occur, the taxpayer generally has two years to replace the property with like-kind property of equal value in order to defer the gain.  For example, if the casualty loss was rental property it must be replaced with similar property, but it does not have to be at the same location, just the same use of the property (income producing property).  The replacement property can not be a vacation home since it is not of similar character.

With nonbusiness property, gain is less likely.  However, if someone has owned their residence for a long period, it is possible there will be a gain.  Again, you generally have two years to replace the property with like-kind property.  However, there is another opportunity if the home is considered your principal residence.  Each individual can exclude gain on the sale of a principal residence of $250,000 ($500,000 for married couple) if they had used the home as the primary residence for 24 months out of the last 60 months and the ownership of the property is relinquished.  Once this principal residence exclusion is used, it usually will reset so that 24 months down the road, you will again have an additional exclusion available to you.  This may provide a unique planning opportunity for some individuals to exclude a portion of the gain rather than to defer the gain.

Reduction in Basis

When a casualty loss is deducted, the taxpayer is required to reduce the basis in the property by the amount of the loss deduction.  This will prevent a double deduction when the property is sold later.

Federal Disaster Area Designation

For Hampden and Worcester counties, the June 1^st Tornados were declared a federal disaster event by the president.  There are a few additional rules available to the taxpayers in these two counties.  First, there will be an extension of time to pay certain taxes and file certain returns to give taxpayers some time to recover and prepare returns.  Any returns or tax payments due from June 1^st through August 8^th have been given an extension of time to file until August 8^th.  There will also be a waiver of penalties and interest.  Second, the replacement period is extended from two years to four years when replacing property or reinvesting within the disaster area.  Third, taxpayers are allowed to choose between the prior year (2010 tax year) and the current year to take the casualty loss deduction.  This may be advantageous for two reasons, to speed up a tax refund and allow taxpayer to maximize the tax benefit of the loss deductions.

Additional information

Additional information can be obtained by consulting the Internal Revenue Service Publication 547 at www.irs.gov/publications/p547, instructions for Federal Form 4684, Casualty and Theft Losses, or by contacting your tax preparer.  It is wise to consult with your preparer well in advance of the tax filing deadline so that you may take full advantage of any elections and planning opportunities.

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was signed into law on December 17, 2010 by President Obama.  Now we must sort through this law to see how it will impact each individual taxpayer. An overview of the changes shows that the Bush tax rates will be extended for two years through 2012. Additionally, there was a 2% reduction to the social security tax withholding for calendar year 2011 and unemployment benefits have once again been extended as part of the negotiated changes to the tax law. On the Estate tax front, there have been significant changes to the federal Estate Tax rules.  With the passage of this tax law, federal estate tax exemptions will rise to $5 million for each taxpayer.  This means that a husband and wife can transfer up to $10 million of assets without a federal tax.  Keep in mind though that many states do have a transfer tax.  Additionally, they have increased the gift tax exemption to $5 million as well.

Be sure to consult your tax preparer and estate tax advisor before making any changes to your current situation.  And, return here to find additional tax tips as I continue to glean through the new law and update this blog.

The Capital Gain preferred tax rate of 15% will be changing back to the 2003 level of 20% should congress not extend. Tax law change made in 2003 will sunset in December 2010. As well, the preferred rate for qualifying dividends will also lose the preferred tax status and return to 2003 tax levels.

Consider accelerating taxable gains into 2010 to take advantage of lower preferred tax rates. Also, consider electing out of any installment gain transactions to tax the entire gain under lower tax rates in 2010.

Things to think about now in advance of meeting with your tax preparer.
- Plan to meet with your accountant early. This will reduce the stress of everyone.
- Review prior year returns for similar information and changes.
- Set up a folder to collect year end tax statements
o W-2 forms
o 1099 forms
o Broker year end statements
- Review your checkbook and summarize tax deductions. Start Now.
o Contributions
o Excise taxes
o Real estate taxes
o Business deductions
- Work with your broker to summarize stock and bond sales
o Gain (loss) sales of stocks and bonds
o Margin interest expense
o Administration fees
- Summarize Business Income and Expenses
o QuickBooks trial balance at year end
o Fixed asset purchases
o Auto mileage and costs