DISASTER RECOVERY OUTLINE OF TAX TOPICS OF CONCERN
Since June 4, 2008, I have added additional important content. In
addition to this article, you are referred to:
Friday, October 7, 2011 “THE PROCESS OF RECOVERY
– POR”
The process of understanding all the
issues that arise in the process of recovering from an individual casualty
event or one that is considered to be a “disaster” can be daunting. Such a
process exists regardless of the event being declared a disaster by the
Governor or the President. The tax related issues alone involve many areas of
tax law that taxpayers do not deal with on a day-to-day basis. These tax laws
become very complex even though they were written, mostly, to reduce the
otherwise onerous impact the tax laws would have on taxpayers in these
situations.
The law is basically divided into two areas, “casualty losses” and “involuntary conversions.” Two taxpayers may find that one of them is covered by the casualty loss rules while the other is covered by the involuntary conversion rules, after the same event. The difference usually centers around the presence of adequate insurance proceeds being paid to the person(s) having experienced the event. Casualty losses are events where there is no compensation or the compensation is less than the costs previously invested by the taxpayer(s) in the property lost. Involuntary conversions result when taxpayer(s) have been or expect to be compensated for their loss in excess of their “sunk” costs in the assets lost.
The list below itemizes important issues for casualty of involuntary conversion events that should be considered. It is not exhaustive, but will start you on the road to asking the questions that are specific to your situation in such situations.
In the work that the firm does assisting individuals and businesses in the process of recovering from a disastrous event, we cover these issues initially and throughout the recovery process. Issues not listed may also arise in some situations.
INCOME AND PROPERTY TAX ISSUES
a. Income Tax Reporting
Review and “revisit” tax returns for the three years prior the year of the event. Discuss the possible correction of previously filed tax returns, net operating loss carrybacks and carryforwards may affect these returns. If you have lost the returns in the event, call the tax preparer for a copy or using IRS Form 4506, available from the IRS website, www.irs.gov, to request old returns.
b. Insured Losses
Computing estimated “gains,” determining the amount deferrable from current tax recognition.
Reporting part or all of the “gain.”
Effect of purchasing personal property to absorb deferred taxable “gain” resulting from the receipt of insurance process for structural damage.
Period of time in which reinvestment must be made - qualifying for an extension of time to complete the reinvestment.
What qualifies as a reinvestment?
Taxation of insurance proceeds for Additional Living Expenses (ALE).
What is deductible as miscellaneous itemized deductions instead of as a casualty loss?
Tax treatment of fees paid to public adjusters.
Defining cost basis of destroyed property.
Tax effects of various SBA loans and FEMA assistance.
Possible deduction of actual loss in excess of insurance reimbursement - the "deductible" portion of insurance, problems of low tax basis and high economic losses incurred.
Interest deduction for remaining vacant land.
c. Experts
How do you treat the expenses paid for experts and advisers who assist in the recovery process - Engineering reports, scope of loss, public adjusters, lawyers, therapists, tax advisers, etc.?
d. Additional Living Expenses and Reimbursements
What is deductible?
What is reportable as taxable income?
e. Property tax issues
Tax reductions while property is being rebuild?
What about ‘moving’ your California Prop 13 tax basis to another residence,
What is replacement tax basis?
f. Court Settlements
“Bad faith” proceeds, additional contractually settled proceeds, punitive damages, treatment of legal fees paid to collect proceeds.
Interest included in court awards.
g. Restoration and Repair
Building up your cost basis
Interest deduction during the restoration process.
h. Business and Non-primary Personal Residence
Disaster “losses and gains.”
Differences from primary personal residence situations.
Allocations, when required, if a business was also operated from the destroyed home.
i. IRS audits
What are the areas that seem to be of most concern to the IRS at this time?
j. Sale of Residence -- Income Tax and Property Tax Aspects
Realized gains vs. recognized gains.
After restoration, or "as is," foreclosure, $250,000/$500,000 exclusion, property tax saving possibilities:
Buying a replacement home.
Use and need for appraisals.
When do you combine the receipts from insurance and the sale of the destroyed home for purposes of reinvesting amounts in a replacement residence?
IRS requirement that personal residence mus be completely destroyed to use $250,000 / $500,000 gain exclusion.
Allocation of basis when purchasing personal property and other residential property to “absorb” realized gain.
Replacing old residence with more than one replacement residence
k. Settlement of any lawsuits -- Income Tax Consequences
These additional amounts may have income tax liabilities over and above any direct settlement amounts received in connection with the claims related to the collection of contractual amounts properly due under the insurance contract.
Additionally, some legal fees paid may have harsh tax results.
l. Death of a Spouse
Tax effects of a death of a person who has deferred gain prior to the full reinvestment of the potentially taxable proceeds.
The law is basically divided into two areas, “casualty losses” and “involuntary conversions.” Two taxpayers may find that one of them is covered by the casualty loss rules while the other is covered by the involuntary conversion rules, after the same event. The difference usually centers around the presence of adequate insurance proceeds being paid to the person(s) having experienced the event. Casualty losses are events where there is no compensation or the compensation is less than the costs previously invested by the taxpayer(s) in the property lost. Involuntary conversions result when taxpayer(s) have been or expect to be compensated for their loss in excess of their “sunk” costs in the assets lost.
The list below itemizes important issues for casualty of involuntary conversion events that should be considered. It is not exhaustive, but will start you on the road to asking the questions that are specific to your situation in such situations.
In the work that the firm does assisting individuals and businesses in the process of recovering from a disastrous event, we cover these issues initially and throughout the recovery process. Issues not listed may also arise in some situations.
INCOME AND PROPERTY TAX ISSUES
a. Income Tax Reporting
Review and “revisit” tax returns for the three years prior the year of the event. Discuss the possible correction of previously filed tax returns, net operating loss carrybacks and carryforwards may affect these returns. If you have lost the returns in the event, call the tax preparer for a copy or using IRS Form 4506, available from the IRS website, www.irs.gov, to request old returns.
b. Insured Losses
Computing estimated “gains,” determining the amount deferrable from current tax recognition.
Reporting part or all of the “gain.”
Effect of purchasing personal property to absorb deferred taxable “gain” resulting from the receipt of insurance process for structural damage.
Period of time in which reinvestment must be made - qualifying for an extension of time to complete the reinvestment.
What qualifies as a reinvestment?
Taxation of insurance proceeds for Additional Living Expenses (ALE).
What is deductible as miscellaneous itemized deductions instead of as a casualty loss?
Tax treatment of fees paid to public adjusters.
Defining cost basis of destroyed property.
Tax effects of various SBA loans and FEMA assistance.
Possible deduction of actual loss in excess of insurance reimbursement - the "deductible" portion of insurance, problems of low tax basis and high economic losses incurred.
Interest deduction for remaining vacant land.
c. Experts
How do you treat the expenses paid for experts and advisers who assist in the recovery process - Engineering reports, scope of loss, public adjusters, lawyers, therapists, tax advisers, etc.?
d. Additional Living Expenses and Reimbursements
What is deductible?
What is reportable as taxable income?
e. Property tax issues
Tax reductions while property is being rebuild?
What about ‘moving’ your California Prop 13 tax basis to another residence,
What is replacement tax basis?
f. Court Settlements
“Bad faith” proceeds, additional contractually settled proceeds, punitive damages, treatment of legal fees paid to collect proceeds.
Interest included in court awards.
g. Restoration and Repair
Building up your cost basis
Interest deduction during the restoration process.
h. Business and Non-primary Personal Residence
Disaster “losses and gains.”
Differences from primary personal residence situations.
Allocations, when required, if a business was also operated from the destroyed home.
i. IRS audits
What are the areas that seem to be of most concern to the IRS at this time?
j. Sale of Residence -- Income Tax and Property Tax Aspects
Realized gains vs. recognized gains.
After restoration, or "as is," foreclosure, $250,000/$500,000 exclusion, property tax saving possibilities:
Buying a replacement home.
Use and need for appraisals.
When do you combine the receipts from insurance and the sale of the destroyed home for purposes of reinvesting amounts in a replacement residence?
IRS requirement that personal residence mus be completely destroyed to use $250,000 / $500,000 gain exclusion.
Allocation of basis when purchasing personal property and other residential property to “absorb” realized gain.
Replacing old residence with more than one replacement residence
k. Settlement of any lawsuits -- Income Tax Consequences
These additional amounts may have income tax liabilities over and above any direct settlement amounts received in connection with the claims related to the collection of contractual amounts properly due under the insurance contract.
Additionally, some legal fees paid may have harsh tax results.
l. Death of a Spouse
Tax effects of a death of a person who has deferred gain prior to the full reinvestment of the potentially taxable proceeds.
This blog,
“AccountantForDisasterRecovery.com” has been addressing taxpayer income tax
issues related to catastrophic losses for five years
All rights to reproduce or quote
any part of the chapter in any other publication are reserved by the author.
Republication rights limited by the publisher of the book in which this chapter
appears also apply.
JOHN
TRAPANI
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Certified
Public Accountant
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2975
E. Hillcrest Drive #403
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Thousand
Oaks, CA 91362
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(805)
497-4411
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Contact us through our website at:
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Blog:
www.AccountantForDisasteRrecovery.com
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It All Adds Up For You
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This material was contributed by John
Trapani. A Certified Public Accountant who has assisted taxpayers since 1976,
in analyzing and reporting transactions of the type covered in this material.
Internal Revenue Service Circular 230 Disclosure
This
is a general discussion of tax law. The application of the law to specific
facts may involve aspects that are not identical to the situations presented in
this material. Relying on this material does not qualify as tax advice for
purpose of mounting a defense of a tax position with the taxing authorities
The
analysis of the tax consequences of any event is based on tax laws in effect at
the time of the event.
This
material was completed on the date of the posting
© 2008, John Trapani, CPA,
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