HOW DOES AN ORDER TO DEMOLISH AFFECT YOU TAX STATUS?

HOW DOES AN ORDER TO DEMOLISH AFFECT YOU TAX STATUS?

IRS website did not include all posts for portion of FEMA’s news releases for some areas included below – Updated, November 20, 21, 27, 28, Dec4ember 6, 17, 2012 , January 6, 2013:

Last week, as a result of Hurricane Sandy, the City of New York issued hundreds of Demolition Orders for homes believed to be unsafe and beyond hope of repair. As reported November 17 in the New York Times:

“New York City Will Demolish Hundreds of Storm-Hit Homes”

“New York City is moving to demolish hundreds of homes in the neighborhoods hit hardest by Hurricane Sandy, after a grim assessment of the storm-ravaged coast revealed that many structures were so damaged they pose a danger to public safety and other buildings nearby. “

The Times reported that…

“No decisions have been made about rebuilding in the storm-battered areas — a complicated question that would involve not only homeowners, but also insurers and officials in the state, local and federal governments. Some of the houses that are being torn down were built more than a half-century ago as summer bungalows, then winterized and expanded. Current building codes would likely prohibit reconstruction of similar homes. “

This blog entry discusses the “order to Demolish,” but the above quote implies an additional issue that may arise, the possibility of immanent domain actions to take the land as the properties may no longer be safe for habitation. It would appear that “condemnation” of the properties would not be a “demolition” as described in this entry unless the IRS makes a specific ruling to the contrary.

An order to demolish your home is a huge emotional hit

The Tax Code gives us limited direction regarding what we should do when after a disaster loss occurs it is followed by authorities ordering properties demolished due to them being unsafe to inhabit or use for commercial purposes. The relevant portion of Internal Revenue Code Section 165 follows:

165(k) TREATMENT AS DISASTER LOSS WHERE TAXPAYER ORDERED TO DEMOLISH OR RELOCATE RESIDENCE IN DISASTER AREA BECAUSE OF DISASTER.—  In the case of a taxpayer whose residence is located in an area which has been determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, if— 

165(k)(1)   not later than the 120th day after the date of such determination, the taxpayer is ordered, by the government of the State or any political subdivision thereof in which such residence is located, to demolish or relocate such residence, and

165(k)(2)   the residence has been rendered unsafe for use as a residence by reason of the disaster,

any loss attributable to such disaster shall be treated as a loss which arises from a casualty and which is described in subsection (i).  

The good news in Hurricane Sandy cases where an order to demolish has been issued and the home is situated in a declared disaster area, is that the demolition is not treated as a separate event that has to be reported on a tax return as another loss. This also implicitly means that where the order is for a home not located  inside a declared disaster area, the demolition is not considered part of the original loss. It must be noted that where a homeowner has made a decision to demolish the structure or where, as part of an insurance settlement process the structure is demolished to rebuild or simply to remove a hazard, the affect is part of the original loss as it is presumed that the decision is simply a part of the overall recovery process.

Let’s look at a possible situation for a “disaster” case.

FACTS: Taxpayer and spouse owned a home for a number of years that they acquired for $200,000. They had not made significant improvements or modifications since the acquisition, but they had maintained the home to a high standard. In late 2012 the home was severely damaged in an event that was later declared a federal disaster. The home was valued at $350,000 at the time of the disaster. After the disaster the property was valued at $200,000, and it appeared that the home could be saved. The insurance company has determined that the loss compensation for the real property is $175,000.

	Before Order to Demolish	Including Order to Demolish
Cost Basis	$200,000	$200,000
Insurance Recovery	175,000	175,000
Market Value Before Loss	$350,000	$350,000
Market Value After Loss	200,000	100,000
Decrease in Value – Economic Loss	150,000	250,000
Loss before Insurance Recovery; Less of Cost basis or Economic Loss	150,000	200,000
Loss Less Insurance Recovery                                    “Loss” Or “–Gain”	$ -25,000	$  25,000

About two months later, in January of the following year, the city ordered the property demolished as it was judged to be a safety hazard and not economically justified to be repaired. The insurance policy had no additional coverage to compensate for the demolition. The city agreed to remove the hazardous structure with funds that were supplied t the city by a federal grant. The structure, which was originally anticipated to be repaired, lost additional value, reducing the value to land value of $110,000 less $10,000 for “debris removal,” for a net fair market value of $100,000.

Because the area was declared a federal disaster area, the tax code relative to demolitions in a federal disaster area became applicable. Since the order was issued within 120 days of the original loss event, the affects of the demolition is combined with the original loss event and will be reported as if additional impact of the order to demolish occurred concurrent with the original loss event.

An important distinction in the tax code is that the 120 days is not counted from the date of the loss, but rather the date of the disaster determination.

For Hurricane Sandy that impacted a number of states, as of November 19. 2012, there have been four federal disaster declarations

Incident Description	120th Day after the Declaration Date
New Jersey Hurricane Sandy (DR-4085) Incident period: Friday, October 26, 2012 Major Disaster Declaration declared on October 30, 2012	2-27-2013
New York Hurricane Sandy (DR-4086) Incident period: Saturday, October 27, 2012 Major Disaster Declaration declared on Tuesday, October 30, 2012	2-27-2013
Connecticut Hurricane Sandy (DR-4087) Incident period: Saturday, October 27, 2012 Major Disaster Declaration declared on Tuesday, October 30, 2012	2-27-2013
Rhode Island Hurricane Sandy (DR-4089) Incident period: Friday, October 26, 2012 to Wednesday, October 31, 2012 Major Disaster Declaration declared on November 3, 2012	3-3-2013
Delaware Hurricane Sandy (DR-4090) Incident period: Saturday, October 27, 2012 to Thursday, November 8, 2012 Major Disaster Declaration declared on November 16, 2012	3-16-2013
Maryland Hurricane Sandy (DR-4091) Incident period: Friday, October 26, 2012 to Sunday, November 4, 2012 Major Disaster Declaration declared on Tuesday, November 20, 2012	3-20-2013
Virginia Hurricane Sandy (DR-4092) Incident period: Friday, October 26, 2012 to Thursday, November 8, 2012 Major Disaster Declaration declared on November 26, 2012	3-26-2013
West Virginia Hurricane Sandy (DR-4093) Incident period: Monday, October 29, 2012 to Thursday, November 8, 2012 Major Disaster Declaration declared on November 27, 2012	3-27-2013
New Hampshire Hurricane Sandy (DR-4095) Incident period: Friday, October 26, 2012 to Thursday, November 8, 2012 Major Disaster Declaration declared on November 28, 2012	3-28-2013
District of Columbia Hurricane Sandy (DR-4096) Incident period: Friday, October 26, 2012 to Wednesday, October 31, 2012 Major Disaster Declaration declared on December 5, 2012	4-04-2013
Massachusetts Hurricane Sandy (DR-4097) Incident period: Friday, October 27, 2012 to Tuesday, November 8, 2012 Major Disaster Declaration declared on December 19, 2012	4-18-2013
Ohio Hurricane Sandy (DR-4098) Incident period: Friday, October 29, 2012 to Tuesday, October 30, 2012 Major Disaster Declaration declared on January 3, 2013	5-3-2013

Section 165(k) specifies that the event must be “determined by the President.” In sub Section 165(k)(1) the Code specifies that that the period cannot be “later than the 120th day after the date of such determination.” Therefore in the case of the states presently declared disasters, it would appear that the 120^th day for these declarations would be as shown in the last column of the above table.

You can see from the table above that the later the declaration determination, the longer the period in which the order may be issued and the order falls within the rules of the Internal Revenue Code. Additionally, for the first two states, New Jersey and New York, the determination was made on October 30, 2012, while the date of the incident was October 26, 2012. For Connecticut, the determination was made on October 30, 2012, while the incident was on October 27, 2012. For Rhode Island, the incident had a period of October 26, 2012 to October 31, 2012, while the declaration date was November 3, 2012. For Delaware, the incident had a period of October 27, 2012 to November 8, 2012, but not declared a disaster area until November 16, 2012.

As long as the municipal authorities act quickly, the distinction of the limitation date may not be an issue. We hope that someone is assisting the applicable municipal authorities with the tax implications of their action on the tax outcomes of their citizens.

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
	Certified Public Accountant
	2975 E. Hillcrest Drive #403
	Thousand Oaks, CA 91362
	(805) 497-4411       E-mail John@TrapaniCPA.com
	Website: www.TrapaniCPA.com
	Blog: www.AccountantForDisasteRrecovery.com
	It All Adds Up For You

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

© 2012, 2013 John Trapani, CPA,