After people endure a disaster, taxes are probably the last thing on their minds. But tax laws do offer some help for loss victims. And victims of a presidentially declared disaster could use their tax filing to obtain much-needed cash.
Taxpayers who itemize are allowed by the IRS to deduct casualty losses -- "the damage, destruction or loss of property from an identifiable event that is sudden, unexpected or unusual." Usually, this means waiting to claim the loss on your next income tax filing.
However, when a house, car or business is damaged or destroyed by an event deemed a major disaster by the president, the wait for tax refund money attributable to disaster losses is cut dramatically. In these extreme cases, taxpayers can deduct their losses in the tax year before the event happened by filing an amended return.
When the Federal Emergency Management Agency, or FEMA, announces that the president declares major disasters in certain areas, usually in the wake of a major storm, the way is cleared for special federal help, including tax options.
Major disaster tax options
Disaster-related tax relief generally includes extended filing deadlines and easing of related penalties for individuals and businesses located in the designated disaster areas. The relief also usually applies to those whose tax records are located in the damaged regions -- at an accountant's office, for example -- and workers from any location who are there providing help to victims.
In addition, taxpayers in federal disaster areas have the option of choosing which tax year to claim the disaster losses. Depending on when the catastrophe occurred, filers can amend a previous year's tax return and claim the catastrophic losses they suffered on the old return. In many instances, amended filing will make the individual eligible for an immediate tax refund -- money that could be used to live on or begin repairs.
This often is the case for filers who didn't itemize deductions the previous year; if the total of the casualty losses and any other itemized deductions will amount to more than the standard deduction they originally took, refiling is generally to their advantage.
Even taxpayers who did itemize might find an amended return worthwhile if the disaster damage produces more than originally deducted.
Not the best move for everyone
While the option to time-shift federal disaster casualty losses to the previous year is a great advantage for some, it's not the best move for all taxpayers.
Some storm victims might find that while their losses are substantial, they aren't sufficient to meet two tax-law limits on casualty claims. First, you must reduce the amount you can claim by $100. Then, you have to reduce the total of all your casualty losses by 10 percent of your adjusted gross income. You also have to subtract any insurance money you got for the loss.
Tax experts also note that people who had very high taxable income the year in which they could claim the losses and expect very low income the year of the disaster might be able to deduct more of their losses by waiting until they file their return the following year.
The deadline for choosing this option usually is the due date of a filer's current year return.
So evaluate your individual circumstances -- tax, damage and financial recovery needs -- carefully. And be sure that the calamity is a certified federal disaster to get the immediate relief.
Paperwork you'll have to file
If you meet the loss limits, the process to claim them is the same regardless of which tax year you choose to file the claim.
The first step is gathering the proper forms. To claim disaster losses, you must file the long Form 1040 individual tax return plus Form 4684 to figure and report your casualty loss and Schedule A to itemize your loss deduction. If you need to file an amended return to claim losses, use Form 1040X instead.
Then determine how the damage has hurt your property's fair market value. This is a two-part valuation: what your property was worth immediately before the catastrophe and what it's worth after.
The pre-disaster value is your "adjusted basis." For homes, this usually is the cost of the property plus certain adjustments such as improvements that add to the structure's value; for vehicles or other personal property, it may be depreciation that reduces its value. Get an appraisal for the post-disaster value of the property and compare it with your adjusted basis. The difference between the two amounts is your loss from the casualty.
Once the loss is determined, use Form 4684 to figure the deductible amount of your casualty loss. You must reduce the initial loss claim amount by any insurance or other reimbursement you have received. If you have insurance on your property, you must submit a claim to use the damage to it as a casualty loss. In other words, you can't decide you don't want to pay the deductible your insurance would require and then use the total, unreimbursed loss amount as your casualty claim. And all insurance payments must be used to repair or replace your property, or any excess not used for these purposes could be a taxable gain to you.
Then this is where the $100 mentioned earlier comes into play. You further reduce your loss by that amount before finally reducing the total yet again by 10 percent of your adjusted gross income to get to your final casualty loss deduction.
Figuring the tax costs of damages
The following work sheet shows the computations that a hypothetical Tom Taxpayer, who suffered through a federally declared flood disaster, had to make. The water substantially damaged Tom's home, the property inside and his car. Insurance covered only a part of the losses.
Tom's adjusted gross income is $60,000, and that's what he uses to figure his casualty deduction. Tom was off work -- and without pay -- for the week that his employer was closed during a flood in May 2014. Unfortunately, Tom can't claim the lost income. The IRS provides no deduction for missed wages, even in the event of federal disasters.
Form 4684 work sheet
|House and land||Property||Auto||Total|
|1. Original property cost||House and land: $100,000||Property: $25,000||Auto: $18,000|
|2. Fair market value (basis) before disaster||House and land: $150,000||Property: $15,000||Auto: $12,000|
|3. Fair market value (appraisal) after disaster||House and land: $75,000||Property: $5,000||Auto: $4,000|
|4. Decrease in value (line 2 minus line 3)||House and land: $75,000||Property: $10,000||Auto: $8,000|
|5. Smaller of line 1 or line 4||House and land: $75,000||Property: $10,000||Auto: $8,000|
|6. Insurance reimbursement||House and land: $50,000||Property: $5,000||Auto: $4,000|
|7. Loss after reimbursement (line 5 minus line 6)||House and land: $25,000||Property: $5,000||Auto: $4,000|
|8. Total loss (total of line 7 entries)||Total: $34,000|
|9. Subtract $100||Total: $100|
|10. Loss after $100 rule||Total: $33,900|
|11. Subtract 10% of adjusted gross income||Total: $6,000|
|12. Deductible disaster loss amount||Total: $27,900|
Now it's time to figure out the "real money" value of Tom's deduction. Remember, Tom's (and your) deduction doesn't directly translate to the amount of whatever refund he (or you) will receive. You must refigure your taxes using this new deduction (entered on Schedule A and Form 1040X) to determine just how much you'll get back.
Tom, a single filer, had decided to amend his 2013 tax return since he took only the standard deduction of $6,100 when he filed for that year. His much larger, disaster-related itemized deduction amount, depending upon how much he paid in taxes that previous year, likely produced a nice refund.
And Tom didn't have to wait to file the amended return. He submitted it as quickly as he could after the major disaster was declared instead of waiting until the 2015 filing season to claim the losses on his 2014 return. As soon as he completed the revised tax paperwork and got it to the IRS, the disaster-related refund was on its way to Tom so he could put the tax cash to work repairing his home.
Tom, of course, carefully considered his filing options and ran the tax numbers for 2013 and projections for 2014, when his property was actually damaged by the rising waters. If he had not been in such dire need of post-flood cash, he could have waited. Depending on your circumstances, you might find it more worthwhile from a tax standpoint to claim disaster losses in the year they occurred.
Cleanup and repair costs
Tom was able to get such a good tax result from his difficult situation because he kept track of what he spent to clean up and repair his property, the main concerns after a disaster strikes.
Keep in mind, however, that the tax laws won't allow you to specifically get back that $5,000 you paid to have the carpets cleaned after the flood. There is no place on Form 4684 for you to enter this expense and have it directly count as part of your casualty loss deduction.
But because your flooring was damaged by the floods, you can use what you spent to repair it as a measure of how much your home's property value was reduced by the storm. This in turn will give you a more accurate assessment of your property's damage and the tax deduction value of the loss suffered.
In Tom's case above, the $75,000 post-disaster value of his home takes the floor damage into account. If the carpets didn't need the professional cleaning, then his home might be worth $80,000. This would mean that the amount he could claim as a casualty loss would be only $22,900, and his tax relief would be less.
The IRS notes that expenses for repairs should take care of the damage only. You can't have the repair crew improve on the original state of your property.
And even though the IRS allows disaster victims some tax leeway, the agency still demands that casualty losses, like every deduction, be substantiated and supported.
The IRS does not require you to keep your records in a particular way, only that you keep them in a manner that allows you and the IRS to determine your correct tax. While you don't have to submit your documentation with your return, you should keep your records handy and be able to show the following if asked.
You should be able to document:
- The type of casualty and when it occurred.
- That the loss amount claimed was a direct result of the casualty.
- That you were the owner of the property or, if you leased it, that you were contractually liable to the owner for the damage.
The simplest way to track loss substantiation is in your checkbook. There you can enter income and loan or insurance reimbursement deposits along with all checks written for expenses accrued in connection with your disaster loss. Be specific: Note amounts, sources of deposits and types of expenses.
Holding on to other documents, such as receipts and sales slips, also can help prove a deduction. Keep your records in an orderly fashion, such as placing documents related to a particular event in a designated envelope, and, where applicable, store them by year and type of income or expense.
And don't forget your camera. Photographs showing the original condition of the property and ones taken after the disaster struck can be helpful in establishing the condition and value of your property.
Other filing rules
When you do send in your amended return, explain that the refiling was due to casualty losses incurred in a federal disaster and attach Form 4684 to show how you figured your loss. Be sure to specify the date or dates of the disaster and the city, county and state where the damaged or destroyed property was located when the disaster occurred.
And what if you thought you escaped, only to find out that the disaster was just a bit slow in arriving? This might be the case if you live in a federal disaster area and state or local officials decide that your home, even though it suffered only minor damage, must be moved or torn down for public safety reasons, such as ensuing mudslides.
You still can take advantage of the casualty loss deduction as long as the government-ordered demolition or relocation of a home is issued within 120 days after the original federal disaster declaration. It might be government contractors doing the damage this time, but your resulting loss is treated just as if it were damaged in the natural calamity.
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