Casualty Gains and Losses

1. Casualty Gains and Losses David Donnelly Gainer, Donnelly & Desroches, LLP

2. Definition of a Casualty • The Code defines Casualty Losses as “losses [which] arise from fire, storm, shipwreck, or other casualty, or from theft”; • Clearly, losses from Hurricane Ike fit within the definition; • In general, the case law indicates that the loss must be sudden • Termite damage, for instance, is not a casualty

3. Calculation of the Loss • The loss is the lesser of • The difference between Fair Market Value immediately before and immediately after the casualty; or • Adjusted basis of the property • If the loss is total, and adjusted basis is higher than Fair Market Value before the loss, the loss is the adjusted basis • Adjusted basis is generally cost less accumulated depreciation • The Loss is reduced by the insurance and/or other compensation received • Casualty Gains are possible

4. Fair Market Value • Appraisals are necessary if the property is not repaired; • Cost of appraisal is a miscellaneous itemized deduction subject to the 2% floor • Cost to repair partially destroyed property to its original condition is evidence of decline in value • Loss is limited to the costs to repair to original condition; any repairs which increase the value of the property over its pre-casualty value don’t increase the loss • No deduction for ‘stigma’ or ‘buyer resistance’ decline in value

5. Limitations on deductions • For businesses, no limitations on deductions • For non business casualty losses, there are two limits • The first $100 of each casualty loss is not deductible, and, • Only amounts over 10% of Adjusted Gross Income are deductible • EXCEPT, in the package of laws known as the “Bailout Bill” • The AGI Limitation is waived for residents of the Hurricane Ike federal disaster area; the $100 threshold is increased to $500

6. Non-itemizers • For individuals who do not itemize their deductions, the ‘Bailout Bill” allows a new standard deduction, which is the sum of: • the basic standard deduction; • The additional standard deduction for individuals who are age 65 or over and/or blind; • the real property tax deduction; • Which is the lesser of the property taxes paid or $1,000 for joint filers; and • the disaster loss deduction. • Only for 2008 returns

7. Timing of the deduction • Casualty losses must be deducted in the year of loss; • If there is a reasonable prospect of recovery, then no loss can be taken. If, in the future, the prospect of recovery ceases to exist, the deduction can be taken in the year the prospect ceases to exist.

8. Federal Disaster Area Rules • For residents of Federal Disaster Areas, the casualty loss deduction may be taken: • in the current year (for Ike, 2008), or • for the previous year • If you have filed your 2007 tax return, it can be amended for the loss • 2007 Returns are now due on January 5, 2009 due to the FDA

9. Federal Disaster Area Rules • If you have a gain on the casualty, you can defer the gain by buying replacement property which is similar or related in service or use • Generally, the rule is within 2 years • Residents of the FDA for Ike have 4 years to replace their principal residence • Replacement of FDA property has a less restrictive standard of replacement property • Basically any trade or business property is considered appropriate if in the disaster area

10. Net Operating Losses • If the Casualty Losses creates an NOL, • Normal rules allow a 2 year carryback and 20 year carryforward • The Bailout Bill allows residents of the FDA a 5 year carryback • For that portion of the NOL caused by the disaster

11. Insurance and Income Tax • For businesses, recovery of lost profits or sales are gross income • If a business has an appropriate reason to not file a claim, they can still get a casualty loss • Such as the potential for increased future premiums • Basis of casualty property must be reduced by the allowed loss, plus insurance proceeds and other recoveries

12. Insurance and Income Tax • If the property is covered by insurance , individuals must file insurance claims in order to deduct a casualty loss • Individuals cannot deduct cost of living expenses when their homes are uninhabitable • If cost of living expenses is covered by insurance, it is not income to the extent it pays for living expenses

13. Filing for the casualty loss • Use Form 4684 • If you aren’t comfortable with the concepts and the form, use a professional; • For big losses generating a NOL, the risk of being audited is generally high

14. For more information, please contact: Contact Name David Donnelly ddonnelly@gddcpa.com (713) 621-8090