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Disaster-Related Tax Deductions and Relief
Hurricanes, floods and other disasters can have devastating effects, including the loss of life and destruction of homes, businesses and personal property. If you suffered a property loss in a disaster, you may be entitled to tax relief and be able to claim deductions for the losses.
Under section 165(i)(1) of the Internal Revenue Code (IRC), there is a special rule that applies to losses taxpayers sustain in a disaster that occurs in an area that is later designated as requiring assistance from the federal government by the President of the United States under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. In these situations, a taxpayer may elect to claim the loss in the year that the disaster happened or in the taxable year immediately before the year of the disaster, regardless of the type of loss. This allows the taxpayer to apply the deduction for the loss in the year that his or her income was greater, leading to a potentially smaller tax liability. If the taxpayer chooses to take the deduction in the year before the casualty, the loss is treated as having actually happened in that earlier year.
There is a time limit for a taxpayer to make an election under section 165(i)(1). To claim a deduction for a disaster loss in the year preceding the year the disaster actually occurred, the taxpayer must do so before (1) the due date for filing his or her income tax return for the taxable year in which the disaster took place (without regarding any extensions), or (2) the due date for filing his or her income tax return for the taxable year immediately preceding the year of the disaster (with regard to any extensions), whichever is later. A taxpayer has up to 90 days after making an election to revoke it. In addition, if the taxpayer has already received a credit or refund because of the election, the taxpayer must generally return the credit or refund to the Internal Revenue Service (IRS) within the revocation period for the revocation to take effect. See Treas. Reg. §1.165-11(e).
If a taxpayer owns a residence in an area declared by the President to require assistance, and if the residence was rendered unsafe for use as a residence because of the disaster and the taxpayer is ordered to demolish the residence or relocate within a certain time period, the loss is conclusively presumed to be a qualified disaster loss. In these circumstances, the taxpayer can deduct a disaster loss even if his or her home is not totally destroyed.
The amount of the deduction for a disaster loss is determined by using the adjusted basis for determining the loss on a sale or disposition of property set forth in section 1011 of the IRC. Generally, if the disaster loss is not related to a trade, business or activity undertaken for a profit, the amount that can be deducted is limited to the amount of the loss that exceeds $100 plus 10% of the taxpayer’s adjusted gross income. See 26 U.S.C. §165(h). There is an exception for people who sustained casualty or theft losses attributed to certain hurricanes. Congress has specified Hurricane Katrina and Hurricane Wilma as such hurricanes. These people are not subject to the limitations in section 165(h).
Individual taxpayers who suffered casualty or theft losses for residential real property used for personal purposes or personal property that was damaged, destroyed or stolen as a result of Hurricanes Katrina, Rita or Wilma are able to take advantage of Revenue Procedure 2006-32’s safe harbor provisions when figuring out the amount of deductions for those losses. Revenue Procedure 2006-32 has three safe harbor provisions that individuals can use to calculate fair market value of personal-use residential real property and one provision that taxpayers can use to calculate fair market value of personal property before the Gulf hurricanes in 2005. If an individual uses one of these safe harbor provisions, the IRS will not challenge his or her calculation of the decrease in fair market value of personal-use residential real property because of Hurricanes Katrina, Rita or Wilma. In addition, the IRS will not challenge a taxpayer’s determination of the fair market value of personal property before the hurricanes if he or she uses the safe harbor provision provided in Revenue Procedure 2006-32.
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