After the Disaster, a Deluge of Financial Worries

Few homeowner’s insurance policies cover damage from landslides.

So how do hillside homeowners in Southern California like those in Laguna Beach grapple with the often-staggering financial loss caused by such events? Here’s a look at some options.

Question: Is disaster assistance from federal and state authorities available?

Answer: Laguna Beach and Orange County officials have declared a local emergency, the first step in obtaining aid, and geologists from the state Office of Emergency Services and the Federal Emergency Management Agency have been assessing the situation.

If the problems are found to be beyond the resources of local and state government, the governor could declare a state of emergency -- something Laguna officials already have asked for -- which would trigger a request to FEMA for a presidential disaster declaration, said OES spokesman Greg Renick. The president’s signature would be necessary to release federal grants and loans.

Q: Is there a way to fast-track the process?

A: Local officials hope to do so by “piggybacking” on President Bush’s previous disaster declarations stemming from last winter’s near-record rains. If the torrents caused groundwater buildup, and that in turn caused the slide, as city officials believe, federal relief money could flow with no need for another declaration.

Q: What kind of aid would be available?

A: FEMA would reimburse local agencies 75% of the cost of restoring infrastructure, and the state would pick up 18.75% of the cost, leaving just 6.25% for the local entities.

FEMA would make household repair grants of up to $5,000 to individuals if they had no insurance or other remedies and had pressing needs such as “a roof over their heads or sanitation,” said FEMA spokeswoman Anjanette Stayton.

FEMA also could pay for temporary housing, counseling and unemployment compensation, but it caps aid at $26,500 per household. The typical payment is far lower: Stayton said the national average for household FEMA aid is $2,500.

The Small Business Administration is authorized to lend disaster victims up to $200,000 to fix or replace a primary residence, $40,000 to replace personal possessions and $1.5 million to repair businesses. It is unclear whether the agency will provide funds for rebuilding in the slide zone.

Q: The loan on my home is now much higher than the property is worth. Can I just walk away and let the bank foreclose?

A: Possibly, but you’d better read your mortgage documents carefully. The reason: Original purchase loans in California are generally non-recourse loans, which means that the bank can take the house, but nothing else.

But if the home has been refinanced, or you have borrowed money using a home-equity line of credit, the rules may be different. If the loan is a recourse loan, the bank can take the property and sue you for any loss it incurs on the balance. In other words, if you owed $500,000 and the bank sold the foreclosed property for $100,000, the bank could go after you to collect the remaining $400,000.

Whether lenders would opt to pursue homeowners in these instances is difficult to predict, said Dustin Hobbs, communications director at the California Mortgage Bankers Assn.

Q: What if it’s not a recourse loan?

A: Foreclosure still could have two negative effects: It slams your credit standing and it could potentially cause tax consequences, said Phil Holthouse, partner in the Santa Monica tax law firm of Holthouse Carlin & Van Trigt.

The difference between the loan amount and the market value of the home can be considered “debt cancellation income.” So if the bank didn’t collect the $400,000 in the previous example, the IRS could add it to the homeowner’s taxable income.

Q: What about bankruptcy?

A: Consult an attorney to discuss the repercussions and options. Although bankruptcy can wipe away certain debts, bankruptcy rules are changing because of a law enacted in April. That measure will make it much more difficult to eliminate debts starting this fall.

Q: What about taking a tax loss?

A: Taxpayers who have a loss from a sudden and unexpected event may claim a casualty loss deduction for losses exceeding 10% of their adjusted gross income, plus $100, Holthouse said. In other words, a taxpayer earning $100,000 a year would be able to deduct the portion of the loss that exceeded $10,100.

The rules are a bit more liberal for losses suffered in a designated federal disaster area, he added. Most significant, casualty losses in disaster areas can be claimed in the year that they happened -- or in the year before. That would allow affected Laguna Beach homeowners to amend their 2004 returns and get immediate refunds, Holthouse said.

Q: What if the loss exceeds my income?

A: The loss can be carried forward on both state and federal returns. In some instances, it also can be carried backward on federal returns, Holthouse said.

But there’s a big caveat on calculating the size of the loss, particularly for those who have owned their homes for some time, Holthouse cautioned. The deductible loss is the lesser of the decline in market value or your tax basis in the home. Your tax basis is the cost of the home, plus the cost of permanent improvements, minus any gains rolled over from previous residences.

“It can be pretty ugly,” he said. “You could have lost a $1-million home and get a tax loss of less than $600,000.”

Q: Is there any way to insure against this type of devastating loss?

A: There are landslide or land-movement policies, said Robert Hartwig, chief economist with the Insurance Information Institute in New York. But this coverage -- like earthquake or flood insurance -- must be bought separately, and it comes with its own set of deductibles and exclusions. Unfortunately, few insurers offer landslide coverage and very few policies are sold, Hartwig added.