Article From HouseLogic.com

By: Gwen Moran
Published: November 18, 2009

Special IRS tax rules benefit homeowners who suffer casualty losses from federally declared disasters during 2009.

Disaster can strike homeowners in any number of ways, from floods and fires to storms and earthquakes. The IRS calls the property damage and destruction resulting from these unexpected calamities casualty losses. For many homeowners, casualty losses are tax-deductible, subject to restrictions.

If you lived in an area hit by a federally declared disaster during 2009, however, the tax code is more forgiving. Fewer restrictions can translate to greater deductions for disaster-related casualty losses. Unless extended, the tax rules, which were loosened by Congress for 2008 and 2009 only, revert back in 2010.

Calculating casualty losses

You didn’t need to live in an area hit by a federally declared disaster in 2009 to be eligible to deduct casualty losses. In fact, casualty losses didn’t even need to be caused by a natural disaster. Losses resulting from vandalism or even terrorist attacks are deductible.

For run-of-the-mill casualty losses, the IRS requires you to determine the fair value of your personal property loss. Personal property could be anything from a big-screen TV to an entire house. Once you place a value, subtract any reimbursements received such as an insurance settlement. From that amount you subtract $500, a requirement known as the “$500 rule,” then you subtract 10% of your adjustable gross income (the “10% rule”). Anything left over is your deductible loss.

That’s a simplified description of the process. In reality, filing for casualty losses can be more complex, warns Phillip L. Liberatore, a CPA in La Miranda, Calif. Everything from your income level to how you value your property can impact deductions. Read IRS Publication 547 (http://www.irs.gov/pub/irs-pdf/p547.pdf) and consult a tax adviser.

Congress revamps rules for 2008, 2009

Some limitations on deductions are waived for homeowners in federally declared disaster areas. While the term “disaster area” is often used casually, an official disaster declaration (http://www.fema.gov/media/fact_sheets/declaration_process.shtm) can only be made by the president through a formal process. When a disaster is federally declared, taxpayers are eligible for additional relief (http://www.irs.gov/newsroom/article/0,,id=141489,00.html).

FEMA keeps a list (http://www.fema.gov/news/disasters.fema?year=2009) of major disaster declarations and emergency declarations that are eligible for favorable tax treatment. When in doubt check with FEMA, or call the IRS disaster hotline: 1-866-562-5227.

The National Disaster Relief Act, passed by Congress in 2008, offers a broad array of tax benefits to victims of federally declared disasters. The benefits are only good for 2008 and 2009, however. Prior to 2008, disaster victims generally had to treat their losses the same as any other casualty losses, unless Congress drafted targeted legislation for specific disasters.

Tax breaks for declared disasters

Before the National Disaster Relief Act was enacted, disaster victims had to itemize returns to take casualty losses, and the losses had to exceed 10% of adjusted gross income. For 2009, those two major hurdles are eliminated for homeowners in federally declared disaster areas. Taxpayers are still required to subtract $500 from losses under the “$500 rule.”

The added deduction for a homeowner can be substantial. Let’s say you have an AGI of $100,000, and a tornado inflicted $20,000 in damage to your house during 2009. Insurance reimbursed $18,000. That leaves a loss of $2,000. Reduce it by $500, and you’re looking at a loss of $1,500, which would be deductible in a federally declared disaster area. Deducting $1,500 from an AGI of $100,000 would save a married couple filing jointly $363 on taxes owed.

But if you lived outside a declared disaster area, you’d also need to apply the “10% rule,” meaning you’d reduce your $1,500 loss by 10% of AGI, in this case by $10,000. That results in a negative number. In other words, none of the loss is deductible.

Disaster losses in 2009 can be taken for the 2009 tax year or for 2008. You’ll need to file an amended return in the latter case. Use Form 4684 (http://www.irs.gov/pub/irs-pdf/f4684.pdf) to figure your disaster loss and report it on Schedule A. If you don’t itemize, use Schedule L.

Dana Andrews, an enrolled agent with Mayer and Associates in Madison, Conn., says the IRS may extend deadlines, such as due dates for estimated tax payments, for taxpayers in federally declared disaster areas. For example, victims of the tsunami (http://www.irs.gov/irs/article/0,,id=213781,00.html) that hit American Samoa on Sept. 29, 2009, were given a three-month extension to Dec. 28.

Take disaster deductions wisely

While the IRS is reasonable when it comes to disaster-related claims, it’s not indulgent, says Andrews. “If you say that a dining room table that cost $1,000 was damaged, you don’t necessarily get to claim that whole $1,000 in the calculation,” he explains. “The IRS will say, ‘It wasn’t antique, and it wasn’t brand new. If it’s a 10-year-old table, maybe you only get to deduct 10% to 50% of that.'”

Liberatore, the California CPA, says returns with large casualty losses have a high rate of audit, so it’s important to document your deductions. Keep careful records, including photos, receipts, and insurance claim reports. If you opt for professional tax help, fees can range from $500 to $3,000, depending on the complexity of the disaster claim. Figure it could take up to a week of your time to assemble documentation and fill out paperwork.

Your state taxes can also be affected by disaster losses. How and by how much varies from state to state, and usually depends on the severity and scope of a disaster, says Liberatore. The best resource for information is your state’s taxing authority, usually called the department of revenue or department of taxation.

This article provides general information about tax laws and consequences, but is not intended to be relied upon by readers as tax or legal advice applicable to particular transactions or circumstances. Readers should consult a tax professional for such advice, and are reminded that tax laws may vary by jurisdiction.

Gwen Moran has been writing about real estate and finance for more than a decade. Her work has been published by Cyberhomes.com, The Residential Specialist, Entrepreneur, On Wall Street, Newsweek.com, Woman’s Day, and Financial Planning.

Reprinted from HouseLogic (houselogic.com) with permission of the NATIONAL ASSOCIATION OF REALTORS®
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