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If your home is damaged during a federally declared disaster or by vandalism or theft, you may be able to claim special tax deductions. Here’s the fine print.
Disaster can strike home owners in any number of ways, from floods, fires, and storms to vandalism or even terrorist attacks. The IRS calls the property damage and destruction resulting from these unexpected calamities casualty losses. For many home owners, casualty losses can be tax deductible. But special rules apply.
Calculating casualty losses
To figure your loss, the IRS requires you to determine the fair value of your personal property. Personal property could be anything from a big-screen TV to an entire house. Here’s a simplified way to calculate your deduction:
- Once you place a value on the personal property, subtract any reimbursements received, such as an insurance settlement.
- From that amount, you subtract $100, a requirement known as the $100 rule.
- Then you subtract 10% of your adjusted gross income (the 10% rule).
- What remains is your deductible loss.
In reality, filing for casualty losses can be more complex, warns Phillip L. Liberatore, a CPA in La Miranda, Calif. Everything from your income level to how you value your property can affect deductions. Read IRS Publication 547 and consult a tax adviser.
Replacement value vs. casualty loss deductions
A common misconception about casualty loss deductions is that they equate to the property’s replacement value. Not so. The amount you can deduct is the lesser of the property’s decreased value or its adjusted basis.
Say you bought a Persian rug for $20,000. Years later it’s stolen, but had risen in value to $50,000. The starting point is $20,000, the adjusted basis, because that’s the lesser of the two amounts. To calculate the deduction, subtract $100 from $20,000, which is $19,900, and then reduce that amount by 10% of your AGI. That’s your deduction.
On the other hand, say you bought a piece of furniture for $50,000. Years later it’s depreciated in value to $20,000 and it’s destroyed or stolen. Your starting point is $20,000, the depreciated value. To calculate the deduction, apply the $100 and 10% rules. What’s left is your allowable deduction.
Tax breaks for declared disasters
Although the term “disaster area” is often used casually, an official disaster declaration can only be made by the president through a formal process. When the president declares a disaster, taxpayers are eligible for additional relief.
For instance, you can claim disaster losses suffered in 2011 on your 2011 tax return or on your 2010 return, whichever is more advantageous. You’ll need to file an amended return if you decide to apply them to 2010. Use Form 4684 to figure your disaster loss and report it on Schedule A.
Here’s how it would work:
Hurricanes prompt the president to issue a disaster area declaration for Joe Carson’s county. Joe’s home suffers $25,000 in non insured damage. His AGI is $60,000 for 2011 and was $40,000 for 2010. If Joe claims the loss on his return for 2011, the allowable deduction is $18,900 ($25,000 minus $100 to $24,900, then reduced by the 10% rule to $18,900).
But if Joe claims the loss on his 2010 return, his deduction increases by $2,000 to $20,900 ($25,000 reduced by the $100 rule to $24,900, then reduced by the 10% rule to $20,900). Claiming the loss in 2010 trims the tax tab by an additional $300 in Joe’s 15% tax bracket, plus applicable state income taxes.
Dana Andrews, an enrolled agent with Mayer and Associates in Madison, Conn., says the IRS usually extends deadlines, such as due dates for estimated tax payments, for taxpayers in federally declared disaster areas. For example, victims of the tsunami that hit American Samoa on Sept. 29, 2009, were given a three-month extension to Dec. 28.
FEMA keeps a list of major disaster declarations and emergency declarations that are eligible for favorable tax treatment. When in doubt, check with FEMA or call the IRS disaster hotline at 1-866-562-5227.
Take disaster deductions wisely
Liberatore, the California CPA, says returns with large casualty losses have a high rate of audit, so it’s important to document your deductions. Keep careful records, including photos, receipts, and insurance claim reports.
If you opt for professional tax help, fees can range from $500 to $3,000, depending on the complexity of the casualty claim. Figure it could take up to a week of your time to assemble documentation and fill out paperwork.
Your state taxes can also be affected by disaster losses. How and by how much varies from state to state, and usually depends on the severity and scope of a disaster, says Liberatore. The best resource for information is your state’s taxing authority, usually called the department of revenue or department of taxation.
This article provides general information about tax laws and consequences, but shouldn’t be relied upon as tax or legal advice applicable to particular transactions or circumstances. Consult a tax professional for such advice.
Gwen Moran has written about finance and real estate for over a decade. Her work has been in Entrepreneur, Newsweek, and The Residential Specialist. A Jersey Shore resident, she’s weathered hurricanes, Nor’easters, and one earthquake.
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