WhenDisaster Strikes

Larry M. Weinstein, CPACertifi ed Tax Reduction Strategist®

9639 Hillcroft Ste 820Houston, TX 77096

(713 ) 726-1603

What Every Houston Taxpayer Needs to Know About HowHurricane HarveyAff ects Th eir Taxes

Copyright © 2017, Larry M. Weinstein, CPA

All rights reserved. No part of this book may be used or repro-duced in any matter whatsoever without written permission of the author, except in the case of brief quotations embodied in critical articles or reviews. This book presents information that is factual as of the time of publication. The information presented here is of a general nature. How the IRS rules and regulations should best be ap-plied is different in every taxpayer’s unique case. Accordingly, no liability can be assumed in how the information is applied to your particular personal situation. No client relationship has been created or can be inferred by purchase of this book.

Why I Wrote This Pocket Guide

Many of my friends, clients and family in Houston Texas were recently flooded as a result of Hurricane Harvey. Some for the third time in the past three years.

Some people will be out of their homes for a few months. Some for a year, maybe more.

Make no mistake. Dealing with a natural disaster is a major ordeal, both physically, emotionally and financially.

Being a CPA, I receive many questions about how these events will affect them on their taxes.

Regardless of your situation, the IRS does have rules in place to help mitigate your loss, even though generally, they will not make you whole again. That is the job of homeowners insurance and flood in-surance.

Natural disasters are addressed by the IRS as a “Casualty Loss”. The rules for Casualty Losses can be confusing and hard to understand.

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Most taxpayers do not know the tax rules con-cerning Natural Disasters because thankfully, they do not occur very often (although it seems to be happening more often in my hometown of Houston Texas!).

In some instances, the IRS may allow you to ac-celerate the casualty loss tax deductions, helping to expedite a refund to help you rebuild your life, sooner rather than later.

If you have suffered a casualty loss, I hope you find the information in this pocket guide helpful.

I wish you all the best in your recovery efforts.If you have any questions concerning how your

casualty loss, affects your tax situation, visit my website (www.SolveMyTaxProblems) for addi-tional information or reach out to me at the office (713) 726-1603.

Larry M. Weinstein, CPACertified Tax Reduction Strategist®

Houston, Texas

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What is a Casualty Loss?The IRS has a special term to describe the loss caused by a natural disaster…Casualty Loss.

A casualty loss is the result from the damage, de-struction, or loss of your property from any sudden, unexpected, or unusual event such as a flood, hur-ricane, tornado, fire, earthquake, or volcanic erup-tion.

A casualty loss is the reduction in the fair market value of your property resulting from a Natural Di-saster.

You have a casualty loss only for actual damage to your property.What A Casualty Loss is Not:A casualty loss does not include:

• Losses from normal wear and tear • Progressive deterioration from age or termite

damage• Losses covered by insurance proceeds• Loss of current income• Loss of future profits• A decrease in the value of your property be-

cause it is in or near an area that suffered a ca-sualty, or that might again suffer a casualty.

• The cost of protecting your property against a casualty or theft

• The amount you spend on insurance or to board up your house against a storm

• The incidental expenses due to a casualty or theft, such as expenses for the treatment of personal injuries, for temporary housing, or for a rental car

What is a Casualty Loss Deduction?The casualty loss deduction is the government’s way of helping taxpayers who have suffered financial losses due to accidents or storms.

The casualty loss deduction is an itemized deduc-tion that serves to increase itemized deductions, de-crease taxable income and hence, decrease Federal Income Tax.

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Taxpayers who can itemize deductions their de-ductions do so, in lieu of taking a standard deduction (which as of Tax Year 2016 is $12,600 for Married Fil-ing Jointly, $6,300 for Married Filing Separately or Sin-gle, and $9,300 for Head of Household).

Itemized deductions generally include real estate taxes, mortgage interest, charitable contributions, medical expenses (subject to certain limitations) and other itemized deductions such as unreim-bursed employee expenses.

What Forms Are RequiredCasualty loss deductions are an itemized deduction and are reported on Line 20 of Schedule A.

Itemized deductions are reported on Schedule A of a Form 1040, U.S. Individual Income Tax Return.

Casualty losses are reported on Form 4684, Casu-alties and Thefts. Line 18 of Form 4684 is reported on Schedule A.

If your casualty loss deduction combined with all other itemized deductions is less than the standard deduction for your filing status, a taxpayer would be better advised to claim the larger standard deduction.

How is the Casualty Loss Calculated?The amount of your loss is generally the decrease in fair market value of the property, or your adjusted basis in the property, whichever is less.

The decrease in market value is the difference be-tween what the property was worth before the casualty and what the property was worth after a casualty.

The adjusted basis is usually your original cost plus the cost of any improvements you’ve made.

You may need appraisals to set the before-and-af-ter values, although what you will have to pay for repairs can serve as evidence of your loss.

When your loss involves several separate items, as would be the case if your home was destroyed by flood, you are expected to calculate the loss for each item rather than come up with an overall estimate and claim the deduction for the total loss for ALL items, as calculated.

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The following items are needed to calculate casu-alty loss:(1) Cost or adjusted basis (cost plus improvements)(2) Insurance Proceeds(3) Fair market value before casualty (4) Fair market value after casualty(5) Decrease in fair market value because of casu-

alty (3)-(4)(6) Choose the lesser of (1) cost or adjusted basis

or (5) decrease in fair market value because of casualty

(7) Subtract insurance proceeds (2) from (6) lesser of cost or (5) decrease in fair market value. This is your Casualty Loss.

In all instances, any insurance proceeds received, reduce the amount of casualty loss deduction. You don’t have a loss and a loss deduction, if you received reimbursement for your loss!!

What are the Limitations on the Casualty Loss Deduction?The casualty loss as calculated above, has 2 limita-tions applied.

The first limitation is that $100 must be subtract-ed from the casualty loss.

This has been in the tax code forever, and I have always found this to be a curiously, small amount of exclusion.

The second limitation is that 10% of Adjusted Gross Income must be subtracted from your casual-ty loss to calculate the deduction.

This means effectively, the first 10% of Adjusted Gross Income is not allowed as a casualty loss. The amount of loss greater than 10% of Adjusted Gross Income is deductible.

What If Casualty Loss Deductions Are More Than IncomeIf your casualty loss deduction causes your deduc-tions for the year to be more than your income for the year, you may have a net operating loss (NOL).

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You can use an NOL to lower your tax in an ear-lier year, allowing you to get a refund for tax you already paid for that year.

Or, you can use it to lower your tax in a later year. You don’t have to be in business to have an NOL from a casualty loss.

Can you Recognize a Taxable Gain as a Result of Your Loss?No matter how much you suffer from a casualty, the tax law might treat you as a winner.

You must report as taxable income any reim-bursement that is more than your adjusted basis in the damaged property.

Assume that you have a replacement value clause in your homeowner’s insurance policy. After a flood, you determine that your basis in destroyed furni-ture and appliances is $10,000, but the replacement value paid by your insurance company is $15,000. Your taxable gain: $5,000.

There is an important exception to this rule. If you use all the insurance proceeds to buy replace-

ment property—that is, items similar to or having a re-lated use as the lost or damaged property—you don’t have to report any of the money as income.

What is a Federally Declared Disaster Area?A federally declared disaster is a disaster that oc-curred in an area declared by the President to be eli-gible for federal assistance under the Robert T. Staf-ford Disaster Relief and Emergency Assistance Act.

It includes a major disaster or emergency decla-ration under the Act. A list of the areas warranting public or individual assistance (or both) under the Act for 2016 is available at the Federal Emergen-cy Management Agency (FEMA) website at www.fema.gov/disasters.

What is “Home Made Unsafe by Disaster”?If your home is located in a federally declared disas-

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ter area, your state or local government may order you to tear it down or move it because it is no longer safe to live in because of the disaster.

If this happens, treat the loss in value as a casualty loss from a disaster. Your state or local government must issue the order for you to tear down or move the home within 120 days after the area is declared a disaster area.

Calculate your loss in the same way as for casual-ty losses of personal-use property. In determining the decrease in FMV, use the value of your home before you move it or tear it down as its FMV after the casualty.

Your home will be considered unsafe only if both of the following apply.•Your home is substantially more dangerous after

the disaster than it was before the disaster.•The danger is from a substantially increased risk

of future destruction from the disaster.

The Role of InsuranceThe amount of your casualty loss deduction is reduced by any reimbursement you receive from insurance.

If you have insurance, you must file a claim or forfeit your right to a tax deduction for the insured part of the loss.

Before this rule was written into the law, some taxpayers chose to go for the tax write-off rather than file a claim and risk cancellation of their poli-cy or an increase in premiums. That’s no longer an option.

Practically speaking, insurance proceeds will generally net a taxpayer much more than the tax saved as a result of the casualty loss tax deduction.

If you can reasonably expect to be reimbursed for part or all of your loss—through insurance or a damage suit—you must reduce your deduction by the amount you expect to receive, even if you won’t receive it until a future year.

If you receive less than you expect, the difference is considered a casualty loss in the year of the final

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settlement.If you receive more insurance proceeds than you

had anticipated and originally used in the casualty loss calculation and deduction, you must include the additional proceeds in taxable income in the following year.

When Can Casualty Losses be Deducted?General Rule-Deduction in the Current YearGenerally, casualty losses must be deducted in the year it occurred, the filing of which would be by April 15th of the following year (or as extended until October 15th). This would require a taxpayer to wait until the next calendar years filing to deduct and claim the loss.

For example, if a casualty loss occurred in Sep-tember, generally the loss would be claimed on the current years tax return, which would not be filed until the next calendar year (due April 15th of the following year or October 15th as extended.)

Thus a taxpayer would be required to wait a num-ber of months to file the tax return and receive the tax benefits and hopefully less tax/larger refund from a casualty loss.Deduction in a Prior YearHowever, if you have a casualty loss occurring in a Federally Declared Disaster area, you can elect to deduct that loss on the previous years tax return (the calendar year in which the casualty loss occurred.)

This may happen in one of two different ways.First, a tax return may already have been filed for

the previous tax year/calendar year of the loss. In that case, an election can be made to file an

amended tax return, allowing you to report the ca-sualty loss and get a quicker deduction for the ca-sualty loss, rather than waiting for filing the next calendar year.

Alternatively, it is possible that a tax return has not already been filed for the previous tax year. In that case, an election can be made for that tax year to report the casualty loss and get a quicker deduction.

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An amended tax return would not be required, as the original tax return for the previous year was never filed and there is nothing to amend.

Claiming a qualifying disaster loss on the previ-ous year’s tax return may result in a lower tax, often producing or increasing a cash refund.If you make the election to amend your prior year return, the loss is treated as having occurred in the preceding year.

Whether you decide to deduct the loss in the current tax year or the previous tax year, include a statement saying that you are making that election.

The statement can be made on the return or can be filed with the return.

The statement must include the name or a descrip-tion of the disaster giving rise to the loss, the date or dates of the disaster, and the city, town, county or parish, state, and ZIP code where the damaged or destroyed property was located at the time of the disaster.

When must you make the election of carryback the loss to the previous year?You must make this election to take your casualty loss for the disaster in the preceding year on or be-fore the date that is six months after the regular due date for filing your original return (without exten-sions) for the tax year in which the disaster actually occurred.

For example, if you are a calendar year taxpayer, you have until October 16, 2017, to amend your 2015 tax return to claim a casualty loss that oc-curred during 2016.

Can you revoke the election to Deduct the Loss in the Preceding/Calendar Year?You can revoke this election on or before the date that is 90 days after the due date for making the election.

You must file an amended tax return for the pre-

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ceding year that contains a revocation statement. The revocation statement must clearly state that

the election is being revoked and include the name or a description of the disaster giving rise to the loss, the date or dates of the disaster, and the city, town, county or parish, state, and ZIP code where the damaged or destroyed property was located at the time of the disaster and for which you originally made the election.

You can provide this information in either the Explanation of Changes in Form 1040X, or other appropriate form or on a statement attached to the amended return.

You must file the amended tax return revoking the election on or before the date you file the re-turn or amended return for the year that includes the loss. You must pay or make arrangements to pay any tax and interest due as a result of the revocation.

Which Year Would It Be Better to Deduct the Casualty Loss?To determine in which year it is best to claim the Casualty Loss deduction, you must know a few things.1. Taxpayers ability to itemize deductions (with and

without the casualty loss). If you are unable to itemize your deductions, either with and without the casualty loss deduction, you will not be able claim the loss.

2. What is the income tax and marginal tax rate for the current and the previous year? The year which calculates the highest marginal tax rate would generate the largest tax deduction and the smallest tax.

3. What year would generate the smallest tax bill? Based upon the marginal tax rate, determine if you should claim the deduction in the current year or the previous year.

4. Taxpayers need for a tax refund. If taxpayer is pressed for funds, perhaps receiving a refund in the current calendar year would be preferable. Casualty losses can put a strain on a taxpayers fi-

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nances. Claiming the casualty tax deduction for the previous years tax year(current year) will ac-celerate a tax refund and put more money NOW in a taxpayers pocket.

How to Treat Qualified Disaster Relief Payments?Qualified disaster relief payments QDRPs aren’t included in the income of individuals to the extent any expenses compensated by these payments aren’t otherwise compensated for by insurance or other reimbursement. You can only receive reimburse-ments for you loss one time!!

These payments aren’t subject to income tax, self-employment tax, or employment taxes (social security, Medicare, and federal unemployment tax-es). No withholding applies to these payments.• Qualified disaster relief payments include pay-

ments you receive (regardless of the source) for the following expenses. Reasonable and necessary personal, family, living, or funeral expenses in-curred as a result of a federally declared disaster.

• Reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence due to a federally declared disaster. (A personal residence can be a rented residence or one you own.)

• Reasonable and necessary expenses incurred for the repair or replacement of the contents of a per-sonal residence due to a federally declared disas-ter.

Qualified disaster relief payments also include amounts paid to individuals affected by the disaster by a federal, state, or local government in connec-tion with a federally declared disaster. These pay-ments must be made from a governmental fund, be based on individual or family needs, and not be compensation for services. Payments to businesses generally don’t qualify.Qualified disaster relief payments don’t include:•Payments for expenses otherwise paid for by in-

surance or other reimbursements, or

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• Income replacement payments, such as payments of lost wages, lost business income, or unemploy-ment compensation.

How to Treat Qualified Disaster Mitigation Payments?Qualified disaster mitigation payments made under the Robert T. Stafford Disaster Relief and Emergen-cy Assistance Act or the National Flood Insurance Act (as in effect on April 15, 2005) aren’t included in income.

These are payments you, as a property owner, re-ceive to reduce the risk of future damage to your property.

You can’t increase your basis in the property, or take a deduction or credit, for expenditures made with respect to those payments.

Proof of Casualty LossFor a casualty loss you must be able to show that there was a casualty. The following show proof of loss: • The type of casualty (hurricane, flooding, storm,

car accident, fire, etc.) and when it occurred. • That the loss was a direct result of the casualty.• That you were the owner of the property, or if

you leased the property from someone else, that you were contractually liable to the owner for the damage.

• Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.

What records are required?You should keep the records that support your loss deduction. You don’t have to attach them to the tax return or the amended tax return (if filed).If your records were destroyed or lost, you may have to reconstruct them. Information about recon-structing records is available at IRS.gov. Type “re-constructing your records” in the search box, or see Pub. 2194, Disaster Resource Guide.

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About the AuthorLarry M. Weinstein is a CPA (Texas) and Certified-Tax Reduction Strategist® from Houston, Texas.

He is the Managing Director of SolveMyTaxProb-lems.com.

Larry graduated from the University of Houston with a BBA in Accounting and began his career in the Houston office of Arthur Young, now known as Ernst & Young.

In private practice since 1988, Larry concentrates in the area of IRS Tax Planning and Preparation, mostly for closely held businesses.

Larry has worked with hundreds of individuals and business owners through the years, helping them to legally lower their taxes and stay compliant with the IRS rules and regulations.

Larry is the developer of the Strategic Tax Re-duction Process™.

Larry lives in Houston with his wife and two daughters. When he is not spending time with his family or watching his girls compete in cheerlead-ing or college lacrosse (Go Texas State Bobcats), he enjoys riding his recumbent trike and bike, photog-raphy, and fishing from his kayak.

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Notes

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Dealing with a natural disaster is a major ordeal, both physically, emotionally and nancially.

The IRS does have rules in place to help mitigate your loss.

Natural disasters are addressed by the IRS as a IRS as a “Casualty Loss”. The rules for Casualty Losses can be confusing and hard to understand.

Most taxpayers do not know the tax rules concerning Natural Disasters because thankfully, they do not occur very often.

IIf you have suffered a casualty loss, I hope you nd the information in this pocket guide helpful.

I wish you all the best in your recovery efforts.

Larry is the developer of the Strategic Tax Reduction Process™.

Larry M. Weinstein is a Texas CPA & Certied Tax Reduction Strategist® from Houston, Texas.