YOUR MONEY: SPOTLIGHT ON TAXES : From Out of the Rubble : Casualty Losses Can Mean a Big Break at Tax Time
The first good news Linda Laxson has had since the Northridge quake shattered her personal effects and cracked apart the walls in her Tarzana townhome is that Uncle Sam stands ready to give her a substantial tax break.
Getting it, however, won’t be easy.
Laxson, whose townhome suffered roughly $26,000 in damage, will need to revise her tax return from last year to get the biggest bang out of her casualty loss buck. Hundreds of other victims of the Southern California quake will either have to compile exhaustive listings of how much they paid for their belongings or find ways to reduce their taxable income if they want to claim this potentially lucrative tax loss.
Casualty loss rules are tricky. But those who negotiate them well can reap hundreds of dollars in tax savings.
How do casualty losses work? And what can you do to get the biggest bang for your buck? Some questions and answers.
*
Q What is a casualty loss?
*
A Any unreimbursed loss to real property from fire, flood, earthquake, theft or any other sudden, unexpected or unusual event. However, stock market reversals, no matter how inexplicable, are not casualties. They fall in the category of capital losses.
*
Q Do I get to deduct the whole loss?
*
A No. You can deduct only the portion that exceeds 10% of your adjusted gross income plus $100.
For example, if you had adjusted gross income of $50,000 and a $10,000 casualty loss, you would be able to deduct $4,900 of the loss. That’s $10,000 minus 10% of your adjusted gross income ($5,000) minus $100.
*
Q That’s a high threshold. Is there any way of lowering the bar?
*
A If you can reduce your adjusted gross income, you get a bigger casualty loss, says Robert Sullivan, tax partner at Stonefield Josephson, a Santa Monica-based certified public accounting firm.
*
Q How do I do that?
*
A Contribute as much as possible to a tax-deferred retirement account, such as a deductible IRA, 401(k) or Keogh plan. Recognize capital losses in your investment portfolio, or defer income. If you are self-employed, you may also want to push discretionary business expenses into the current year to reduce your self-employment income, Sullivan says.
But don’t defer so much income that you go into a higher tax bracket next year, warns Gregg Ritchie, partner in the personal financial planning group at KPMG Peat Marwick. Paying tax in a higher bracket in 1995 can cost you more than you saved with the boosted 1994 casualty loss.
*
Q How much can tax planning really boost my casualty loss?
*
A Let’s say our $50,000 wage earner opted to contribute $8,000 to a 401(k) and recognize a $3,000 capital loss from a money-losing stock. That reduces his adjusted gross income to $39,000 and increases his casualty loss deduction to $6,000 ($10,000 minus $3,900 minus $100). Assuming he’s in the 28% tax bracket, that saves him $1,680 in taxes--$308 more than he would have gotten if he had taken no steps to reduce his income.
*
Q How about boosting my itemized deductions? Does that help?
*
A No. While itemized deductions reduce your taxable income, they do not affect your adjusted gross income, which is the number used to determine the deductible portion of your casualty losses.
*
Q My income was much lower in 1993 than it was this year, which would make it easier to get a deduction for my casualty. Is there any way I can push my casualty loss into last year’s tax return and claim a refund?
*
A Yes. In federally designated disaster areas, you get the option of claiming the loss in either the year it happened or in the previous year. If you would get a bigger deduction by claiming the losses on last year’s return, you can file a 1040X form--an amended return--and have the IRS send you a refund for the tax savings you realized by claiming the casualty loss in that year.
Incidentally, this is exactly what Laxson is doing, but for a somewhat different reason. She lost her job in 1994, so she’s paying very little tax this year. If she pushes the deductions into 1993--a year in which she paid tax on roughly $48,000 in income--she stands to get a more substantial refund.
*
Q Are there any tricks to determining the extent of my loss?
*
A Plenty. The IRS’ favorite method for determining your loss is an appraisal method, says Ritchie. In essence, the taxpayer gets appraisals before and after the disaster. The difference in value is the extent of your loss, with some caveats.
The first caveat is that a temporary drop in value due to “resistance” to buying a home in a disaster zone has to be factored out. That’s because such reluctance is temporary and presumably will evaporate without any capital outlay on your part.
*
Q How do you determine how much of the loss is due to buyer resistance?
*
A There’s no foolproof answer, says Ritchie. It’s a subjective determination you arrive at with the help of an appraiser or a tax professional.
*
Q Is there a less subjective way to determine the loss?
*
A Yes. The value of your loss can also be established by the cost of repair. This method is less appealing to the IRS, but it’s easier to substantiate, accountants say.
*
Q So, my casualty loss is just the cost of repairs minus any insurance reimbursements?
*
A Sometimes, but not always. If the cost to repair is greater than your “tax basis”--what you paid to buy and improve the property--your deduction is limited to the lower of the two.
*
Q I bought my home ages ago for a fraction of what it’s worth today. As a result, my insurance reimbursement was substantially more than the original cost of the property. Do I have a casualty gain?
*
A Very likely, says Ritchie. Consider a hypothetical consumer, Jane Quaker, who bought her house for $80,000 and made $5,000 in improvements over the years. Her adjusted basis is $85,000. If the insurer gives her $90,000 to repair earthquake damage, she has a $5,000 casualty gain, he notes. The gain will increase your tax basis in the house, however, which can be useful later.
In a few instances, there may have been a step-up in basis that would eliminate the casualty gain. That would happen, for example, if you were married and owned the home jointly with a spouse who died sometime after the home’s purchase. At the time of your spouse’s death, the tax basis in the home is kicked up to the value of the property at the date of death.
