tax practice corner
Documenting a Casualty Loss
By Gerard H. Schreiber Jr.
The ordeals of hurricanes Katrina, Rita and Wilma in 2005 and Gustav and Ike this year taught us in the Gulf Coast a lot about serving clients who have experienced casualty losses. Here are some ideas to keep in mind if you ever have to help your clients rebuild their lives and finances after a hurricane or similar catastrophe.
FMV OR BASIS?
Individual losses are concerned with the decline in fair market value of property as a consequence of the event, and business losses are concerned with the basis of the asset. Individual losses will be separated into real and personal property on Form 4684, Casualties and Thefts.
RECORDS LOST OR DESTROYED
The overwhelming circumstances of a disaster are difficult enough without having to reconstruct the information needed to calculate a casualty loss. Nonetheless, patience and frequent communications with clients on valuation issues are a must.
Real property. The fair market value before and after of real property should be documented by an appraisal, sometimes requiring more than one. Also, insurance adjusters’ reports are generally a good source of details on the extent of damage, dimensions and floor plan of a residence or other building, and how much it will cost to replace.
Personal property. Determining fair market value before and after of personal property is more difficult. Again, insurance adjusters’ reports may provide information on date acquired, cost or basis, and fair market value before and after. Cost information may be obtained from credit card receipts for some items. Some values may be obtained from Web sites such as eBay. But be prepared to deal with property inherited and gifted as well. Pictures of property may be helpful and sometimes can be obtained by clients from their relatives and friends.
Estimating values. There will be instances where there are no records to substantiate the cost and date acquired on personal property, and it is impractical to obtain microfilm copies of bank records. Statement on Standards for Tax Services no. 4, Use of Estimates, provides guidance for AICPA members who have to use estimates on a tax return. Reasonable estimates for computing basis have been recognized by courts in some circumstances under the Cohan rule (George M. Cohan v. Commissioner, 8 AFTR 10552 (2nd Cir., 1930)). For the rule’s application to hurricane flooding, see Clarence R. Howard v. Commissioner (TC Memo 1981-271).
CODE SECTION 165
The general rules under IRC § 165 are followed concerning the deductibility of the loss, timing of the deduction, and prospect of recoveries from insurance or otherwise.
Special timing rules for presidentially declared disasters. Casualty losses for presidentially declared disaster areas can be deducted in the year incurred or in the preceding year. See IRC § 165(i). The purpose of this provision is to provide some immediate cash to those who have experienced disaster losses. Also, section 7508A provides up to a one-year delay in filing and payment and other requirements listed in section 7508(a)(1), including filing a claim for a credit or refund. See also Revenue Procedure 2007-56 for a detailed list of elections and other acts that may be postponed.
AID AS AN OFFSET TO LOSS OR TAXABLE AS INCOME
Questions about income or reimbursement of loss from such sources as FEMA payments, grants and other aid may come up. IRC § 123 excludes from gross income insurance payments for living expenses for taxpayers whose principal residence is damaged, destroyed or declared off-limits, but only by the amount actual expenses exceed normal living expenses. Likewise, a qualified disaster relief payment under section 139(a) is excluded from income. Grants and other aid payments designated to repair or replace property, however, generally must offset any claimed casualty loss.
Much other helpful information is included in the AICPA Casualty Loss Practice Guide. The Practice Guide also provides references to authorities, discussion and examples for computing casualty losses, and treatment of insurance reimbursements. In addition, the IRS has published extensive information including “FAQs for Disaster Victims” (www.irs.gov/businesses/small/article/0,,id=156144,00.html). You also will need IRS Publication 584, Casualty, Disaster, and Theft Loss Workbook (www.irs.gov/pub/irs-pdf/p584.pdf), which contains worksheets on which taxpayers can compile information on their household belongings.
By Gerard H. Schreiber Jr., CPA, a partner with Schreiber & Schreiber CPAs in Metairie, La. He is a member of the AICPA’s IRS Practice & Procedures Committee and SSTS Revision Task Force and has authored courses and articles on various tax subjects. His e-mail address is email@example.com.