Fire Victims Face Hurdles to Get IRS Tax Breaks

Whether or not you lost your home in the recent Southern California fires, here’s some bad news: If you have financial woes because of fire damage, don’t look to the Internal Revenue Service for an easy tax break.

Don’t misunderstand. Federal tax authorities do allow deductions for casualty losses. If you are in a specially designated disaster area, you can even use these deductions to get a refund on last year’s tax return. That, theoretically, should give you some cash now when you need it to rebuild or replace uninsured belongings.

But there are hurdles to clear before you can claim a casualty loss. And for people who lost their homes and personal belongings, those hurdles may prove daunting, accountants say. Indeed, disaster victims are more likely to flirt with casualty “income” than casualty losses. That’s because some insurance payments are taxable.

What are the tax issues that disaster victims must consider? Here’s a look.

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Q. What’s a casualty loss?

A. It’s a loss of property resulting from “a sudden, unexpected or unusual event,” such as a fire, storm, tornado, hurricane, earthquake, flood or shipwreck.

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Q. How much of my loss is deductible?

A. For personal property, you can deduct unreimbursed losses that exceed 10% of your adjusted gross income plus $100. In other words, if you earn $50,000 and you have a $10,000 un-reimbursed casualty loss, you can deduct $4,900. That is $10,000 minus the sum of $100 and 10% of your adjusted gross income. ($50,000 times 10% equals $5,000, plus $100 equals $5,100.)

If you lost your business rather than your home, you are not subject to the deduction thresholds--the entire loss can be deducted against your business income, says Martin Bush, managing editor of the federal tax reporting group at Commerce Clearing House in Riverwood, Ill.

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Q. Do I have to subtract insurance proceeds before calculating the casualty loss?

A. Yes. The previous example assumes that the entire $10,000 loss was uninsured. If, instead, your insurance policy paid $5,000 of the $10,000, you would not be able to claim a casualty loss.

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Q. A lot of my unreimbursed losses related to temporary living expenses. Are these deductible?

A. No. Treatment of personal injuries, cleanup costs, temporary housing costs and car rentals are not deductible as casualty losses. Indeed, if insurance payments for temporary living expenses exceed your actual increase in living expenses, the difference can be considered taxable income, says Art Berkowitz, a Laguna Niguel-based certified public accountant.

Consider someone who gets a $3,000 monthly insurance payment to rent another comparable home. He spends only $2,000 a month and saves the rest. That $1,000 monthly difference is taxable income, Berkowitz says.

On the other hand, some fire-related expenses may be deductible on other parts of your return. For instance, if you were injured in the fire and have unreimbursed medical expenses, add those costs to all other unreimbursed medical expenses incurred during the year. You can claim a medical expense deduction to the extent that these costs exceed 7.5% of your adjusted gross income.

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Q. My home was destroyed. How do I calculate my casualty loss?

A. This is the hard part, says Harvey Gettleson, partner at Ernst & Young in Los Angeles. The casualty loss on your home is equal to the lesser of the decrease in fair market value before and after the fire, or the property’s adjusted cost basis, including the rollover of gain.

For example: The house that burned down is the first home you’ve purchased and it cost you $200,000. You spent another $8,000 on landscaping before the fire. Your “adjusted cost basis” is $208,000.

Meanwhile, before the fire, an appraiser valued the home at $300,000. After the fire, the appraiser says the empty lot is worth just $50,000. The $250,000 difference is the decrease in fair market value after the fire.

Assuming that none of your loss is reimbursed, your casualty loss is $208,000--or the lesser of the two amounts.

You determine the casualty loss on your personal items separately but in the same basic fashion, Gettleson adds. You get the lesser of what you paid or what those goods are worth today, minus insurance proceeds.

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Q. What information do I have to provide to the IRS to prove I’ve got a casualty loss deduction?

A. You need to keep a variety of records, including receipts that show what you had, what you replaced, what you paid for it and insurance reimbursements. You’ll also need to show whether or not you claimed any “salvage” income--what you make by selling salvageable debris to a salvage company, perhaps the used bricks from your fireplace or the surviving commode. And you’ll need to keep appraisal reports that note the fair value of the property before and after the fire.

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Q. Appraisals cost money. Do I really need one to claim a tax loss?

A. If you have a fairly recent appraisal--perhaps from a refinance--you may be able to get by without a new one. But in most cases, you’d be wise to pay for a certified appraisal if you’re planning to take a casualty loss deduction, experts say.

There are two reasons. First, a certified appraiser is in a better position than you to figure out exactly how much value you lost in the fire. You may find the taxable loss is higher than you think.

Second, casualty losses are generally considered to be so-called audit triggers that single your return out for greater IRS scrutiny. If you can substantiate your losses with good documentation, you may be able to avoid a full-scale audit. On the other hand, if your documentation seems shaky, an examiner may decide to audit your whole return, Gettleson notes.

To top it off, appraisal expenses are deductible as “miscellaneous” itemized deductions.

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Q. What do I do if I get audited? All my tax records were lost in the fire.

A. Contact the IRS. Despite the agency’s fierce reputation, tax experts maintain that the agency is willing to help out, particularly in difficult times such as these. In many cases, audits can be postponed until you can re-establish your records by getting copies of forms and information from your attorney or accountant.

You can also get copies of your tax returns from the IRS and the Franchise Tax Board (for California state returns). For further information, call the IRS at (800) 829-3676 or the FTB at (800) 852-5711.

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Q. How do I claim a refund against last year’s return?

A. You can file an amended tax return, Form 1040X. The form will ask you to delineate the changes from the previously filed return. If those changes result in an overpayment, the IRS will send you a refund check.

However, if you’re filing a casualty loss claim, you would be wise to consult a professional tax adviser--even if you normally file your returns yourself. This part of the tax code is complicated, and doing it yourself can result in errors and loss of deductions, not to mention serious frustration. It’s worth noting that tax preparation expenses are also deductible.