FAQs for Hurricane Victims - Casualty Loss (Valuations and Section 165 (i))
FAQs for Victims of Hurricanes Katrina, Rita and Wilma, Victims of the May 4, 2007, Kansas Storms and Tornadoes, and Victims of the Midwestern Area Disasters of 2008
(03/09) Q: Can you provide an example of how the casualty loss, reimbursement and basis rules work and how the non-recognition rules apply under Internal Revenue Code Sections 121 and 1033?
A: Below are facts and consequences on how the casualty loss reimbursement and basis rules work.
Taxpayer's pre-disaster basis in the property is $215,000.
2005: Taxpayer has a casualty loss of $22,000. Taxpayer receives insurance reimbursement of $7,000 and has no reasonable prospect of recovering any other amounts for damage to the home.
2006: Taxpayer repairs property at a cost of $25,000. Taxpayer receives state grant of $18,000 to reimburse the portion of the cost of repairs not covered by the insurance reimbursement.
2005: Casualty loss deduction = $15,000 ($22,000 less $7,000).
2006: Income due to recovery of benefit of $15,000 casualty loss deduction from receipt of state grant = $15,000.
|2005 casualty loss deduction||($15,000)|
|2005 insurance reimbursement||($7,000)|
|Basis at the end of 2005||$193,000|
|2006 Amount of state grant in excess of amount of recovery of tax benefit income (18,000 less $15,000)||($3,000)|
|Basis at the end of 2006||$215,000|
The non-recognition provisions of §§ 121 & 1033 apply only when a taxpayer receives reimbursement/ compensation (e.g., insurance proceeds, grants, etc.) in excess of the taxpayer's tax basis in the property, which is not the case in this example.
(03/09) Q: Can a taxpayer amend a previously filed return to take the loss on a vacation home that resulted from one disaster and also take the casualty loss on his main home for the current tax year? Or must it all be on one year?
A: Treas. Reg. § 1.165-11(d) indicates that the § 165(i) election applies to the entire loss sustained by the taxpayer from a particular disaster. For example, if a taxpayer elected under § 165(i) to deduct in the 2004 tax year losses to his or her vacation home attributable to Hurricane Katrina, then the taxpayer must have reported all Katrina-related losses that qualify for the election on the 2004 tax return. If that same taxpayer experienced losses attributable to Rita, rather than Katrina, then the Rita-related loss is from a separate disaster and may be deducted in either 2005 or in 2004 if the taxpayer makes the § 165(i) election.
A recent change in the tax law allows a homeowner who claimed a casualty loss with respect to their main home for damage from hurricane Katrina, Rita, or Wilma, and in a later tax year received a certain grant, such as a Road Home grant, as reimbursement for the loss, to amend the tax return on which the taxpayer claimed the casualty loss to reduce the loss by the amount of the grant, rather than report the grant as income in the year received. For more information, see Notice 2008-95, Notice to Address Amended Returns for Hurricane-Related Casualty Losses and Subsequent Grants Reimbursing Such Losses. Also see the section on "Amended Returns" in the FAQs for Disaster Victims for more information on this change in the tax law.
(03/09) Q: The Katrina/Rita safe harbor methods are for personal use property only. Are they also allowable for personal residences with a home office or a spare room which is rented out or half a duplex which is rented? If so, how are these treated?
A: The safe harbor methods provided in Revenue Procedure 2006-32 for personal-use residential real property may not be used for personal-use residential real property that is used in a trade or business or in a transaction entered into for profit. Therefore, if a taxpayer’s personal-use residential real property includes a residence that contains a home office used in a trade or business or if the taxpayer rents part of the residence to another individual or individuals, the taxpayer may not use any of the three personal-use residential real property safe harbor methods.
However, if the taxpayer owns two or more units in a contiguous group of attached residential units, such as a duplex, and rents one of the units or uses one of the units as a home office, then the taxpayer may only use the personal-use residential real property safe harbor methods for the unit or units that the taxpayer does not use in a trade or business or in a transaction entered into for profit.
(03/09) Q: May taxpayers use the three safe harbor methods described in Revenue Procedure 2006-32 for mobile homes or trailers used as personal residences that were damaged or destroyed by Hurricanes Katrina, Rita or Wilma?
A: The revenue procedure excludes both mobile homes and trailers from the definition of personal residence. Therefore, taxpayers may not use any of the safe harbor methods for mobile homes and trailers that were damaged or destroyed by Hurricanes Katrina, Rita or Wilma. Taxpayers may determine the decrease in fair market value of a mobile home or trailer by consulting established pricing sources. Another 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 Publication 547, Casualties, Disasters, and Thefts for further information on computing a casualty loss.
(07/09) Q: If you prepared your 2005 Form 1040 before Revenue Procedure 2006-32 was published, can you amend the 2005 Form 1040 to use one of the safe harbor methods in Revenue Procedure 2006-32 in determining a casualty loss from hurricane Katrina, Rita, or Wilma?
A: Yes. As long as the return is timely amended.
(03/09) Q: Can Rev Proc 2006-32, Table 2 (Near Total Loss) be used in a two-story home where only the first floor was devastated? Is there a procedure for two-story homes since Table 2 applies to the first floor only? Can Table 4 be used for the upstairs?
A: A taxpayer whose personal residence was subject to a Near Total Loss, as defined in section 3.03(2) of Revenue Procedure 2006-32 may not use any tables in addition to Table 2 in determining the decrease in fair market value of the taxpayer’s personal residence. The taxpayer may use Tables 6 and 7, if applicable, in conjunction with Table 2, to determine the decrease in fair market value of the taxpayer's personal-use residential real property. Section 4.04(2) of the revenue procedure describes what tables may be used together in applying the cost indexes safe harbor method.
(03/09) Q: If an individual discovers an additional Katrina, Rita, or Wilma casualty loss in 2006, will the $100 and 10 percent of adjusted gross income casualty loss limitations on the individual’s casualty loss deduction be imposed in that year?
A: As long as the casualty loss for the individual taxpayer arises in the Hurricane Katrina disaster area on or after August 25, 2005, in the Hurricane Rita disaster area on or after September 23, 2005, and in the Hurricane Wilma disaster area on or after October 23, 2005, and is attributable to Hurricanes Katrina, Rita or Wilma, then the $100 and 10 percent of adjusted gross income limitations would not apply. Similar information pertains to the May 4, 2007, Kansas Storms and Tornadoes and the Midwestern disasters of 2008.
For more information on these disasters, see:
Publication 4492-A, Information for Taxpayers Affected by the May 4, 2007, Kansas Storms and Tornadoes
(03/09) Q: May a taxpayer use Table 4, “Structural damage from wind, rain, or debris,” in Revenue Procedure 2006-32 if the taxpayer needed to replace the drywall or other wall frame coverings for only one wall or only for the ceiling within a room?
A: A taxpayer may use Table 4 if:
The taxpayer’s personal residence sustained major structural damage to the roof and/or outside walls as a result of wind or windblown debris from one of the 2005 Gulf hurricanes.
The structural damage exposed part or all of the interior of the personal residence to rain or debris causing damage to the interior portions of the residence that requires substantial renovation. Substantial renovation, as defined in section 3.05(4) of Revenue Procedure 2006-32, requires the removal and replacement of drywall or other wall frame coverings, replacement of trim, and repair and painting of the damaged interior areas of the personal residence. A taxpayer determines the square footage of the damaged portion of the personal residence by adding together the square footage of each room needing substantial renovation. A room requires substantial renovation if at least one wall or the ceiling sustains damage requiring the removal and replacement of drywall or other wall frame coverings, replacement of trim, and repair and painting of the damaged portions of the room.
(03/09) Q: A taxpayer had $175,000 in out of pocket losses from a tornado spawned during Katrina. Her insurance company offered $40,000. Under the terms of the policy she entered into mediation. The mediator that she engaged calculated that she had $140,000 in covered losses. The company's mediator presumably came up with a lesser number. The matter has been settled for $110,000. Assuming that the difference between the $175,000 out of pocket and the $140,000 that the mediator calculated was uncovered losses, would her mediator's detailed calculations represent a reasonable backup for her covered loss? The mediator in this case was being paid on a percentage basis and therefore did have a vested interest in the calculation. Also, is the mediator's 10 percent a part of the loss?
Another taxpayer hired an adjuster to determine damage to everything other than landscaping in a Wilma-related loss. Adjuster was paid a flat fee. His calculations include both items that were covered by insurance and items that were not. Are his calculations of the uninsured items reasonable backup for those losses or should my client engage an appraiser? Is the adjuster's fee part of the loss?
A: To compute a deductible casualty loss, taxpayers need to determine: (1) the difference between the fair market value of the property 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 other form of compensation taxpayers receive or reasonably expect to receive. Section 1.165-7(a)(2) of the Income Tax Regulations provides two methods for taxpayers to determine the decrease in fair market value of the 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. See § 1.165-7(a)(2)(i). The second method is the cost to repair the property. See § 1.165-7(a)(2)(ii). 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 immediately 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 immediately before the casualty.
In addition to the two methods in the regulations, Rev. Proc. 2006-32 provides additional methods that individual taxpayers may use in determining their casualty and theft loss deductions under § 165 of the Internal Revenue Code. The safe harbor methods apply to personal-use residential real property and certain personal belongings damaged or destroyed as a result of Hurricanes Katrina, Rita or Wilma. The revenue procedure provides three safe-harbor methods that individuals may use to determine the decrease in fair market value of personal-use residential real property. The revenue procedure also provides a fourth safe harbor method that individuals may use to determine the fair market value of certain personal belongings immediately before Hurricanes Katrina, Rita or Wilma.
Taxpayers may not deduct as part of their casualty loss fees paid to a mediator or adjuster since these costs do not constitute a loss of property under § 165(c)(3).