See our last post on tax extensions recently granted to individuals, businesses, firefighters and relief workers in California Counties: Butte, Lake, Mendocino, Napa, Nevada, Sonoma and Yuba.
Losing a loved one, a home, or a livelihood due to a natural disaster is among the worst things that can happen to a person. And the last thing you should be worrying about in times of crisis is your tax bill.
If you are in a county that has been federally declared a disaster area, you have the ability to elect to amend your prior year’s tax return to deduct your casualty loss so you can receive your refund without waiting to file your tax return in the next year as normal. There is even a special processing of the amended prior year’s tax return to get you your refund extra fast.
If you have been affected by the horrific fires raging through Northern California, you may be entitled to federal disaster assistance and tax relief, right now. You may also be entitled to an IRS refund or a federal disaster loan right now.
The tax law generally allows casualty losses for certain property damaged in a "sudden, unexpected or unusual event" such as a hurricane, flood, earthquake or fire.
26 U.S. Code § 165 allows a deduction for certain losses not compensated by insurance or otherwise. If your property is insured, you must file a timely claim and must reduce your loss for tax purposes by any insurance proceeds received. For individuals, but not businesses, the loss must exceed 10% of your adjusted gross income to benefit from this tax relief.
If the damage was to business or income property, different rules apply. If your investment property or property held for productive use in a trade or business is involuntarily converted due to "destruction, theft, seizure, requisition, or condemnation," and you receive cash or other property as compensation, that will be treated as property similar to the converted property under 26 U.S. Code § 1033. This means that you will either not recognize any gain, or will be able to defer recognition of a gain, depending on the circumstances. Losses may be allowed by other code sections, including 26 U.S. Code § 1211 Limitation on Capital Losses. However, you have a statutory limited time to use the insurance money to replace the business property in order to avoid being taxed and this period varies depending on your facts and circumstances.
The IRS acknowledges that valuable time and customers are lost when a business cannot operate for a period of time. For example, in Technical Advice Memorandum 201111004, a business owner whose property as damaged by the 2006 Gulf Coast hurricanes and who used insurance proceeds to rebuild his business was not forced to recognize gain on the excess of basis from his recovery – neither on his new business property nor on his inventory.
Special loss provisions
There are special loss provisions that apply to property damaged by a federally declared disaster, including:
- Instead of deducting a casualty loss in the year in which it occurred, you may choose to deduct the loss for the previous tax year by filing an amended return – the intent is to get your refund in hand as soon as possible.
- For small businesses with annual gross receipts of less than $5 million, the carryback period for net operating losses is three years instead of the usual two.
Federal disaster relief grants and loans
The U.S. Federal Emergency Management Agency (FEMA) provides both grants and loans to homeowners and renters in federally-declared disaster areas. This assistance is generally available to anyone, regardless of income, and is intended to assist victims with serious disaster-related expenses such as temporary housing, emergency home repairs, personal property losses, medical and dental needs, funerals, and more. All requests are evaluated on a case-by-case basis.
While FEMA loans must be repaid, FEMA grants need not be repaid and are not taxable to individuals. Note, however, that if a grant is used to contribute to the capital of a corporation, they may be includable in gross income under 26 U.S. Code § 118.
A Personal Note
We are keeping our many family members, clients, colleagues and friends in our thoughts who are affected by these devastating fires and our thoughts and hearts go out to all those whose lives it has touched. The outpour of assistance and kindness in the face of destruction offers humbling reminders of humanity’s willing to help one-another.