Welcome to hurricane season! Hurricanes can cause quite a bit of damage not only to vacation homes, but also to the primary residences of people who live in areas affected by hurricanes. In 2005, Hurricane Katrina caused more than $125 million in damage.
However, hurricanes are not the only causes of natural disasters. Quite a bit of damage can be done by tornados, rock slides, and floods. What do you do if your home is affected by a natural disaster?
What is a natural disaster?
For tax purposes, in order for you to be able to claim a loss due to a natural disaster, the President of the United States must declare the area declared to be eligible for federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. You can check the FEMA website at http://www.fema.gov/disasters to see if this applies to the damage done to your property.
Amount of the loss you can deduct
There are three steps you need to take to determine the amount of the loss.
First, determine your adjusted basis in the property before the event occurred.
Second, calculate how much the fair market value of your property decreased due to the disaster.
Third, take the smaller of those two amounts and deduct any insurance or other type of reimbursement you received or expect to receive. If you end up with a gain because the insurance coverage is larger than the loss of fair market value or the adjusted basis, you will be taxed on that gain.
There are limits to what you can deduct. You will have to reduce each individual event loss by $100. Additionally, you will have to reduce your total loss by 10 percent of your adjusted gross income after applying the 10 percent rule.
This formula may well sound confusing to you. If so, we would be happy to do the calculations for you.
In most cases, you need to deduct a loss in the year the disaster occurred. However, if you have a loss from a federally-declared disaster that could receive public or individual assistance, you can take the loss as you prepare your taxes for the previous year (this may require amending a completed return). The benefit of doing this is that it will result in a lower tax bill, which could generate a refund (or increase a refund you were due to receive).
Forms to use
You would report a loss on personal use property on Form 4684, Casualties and Thefts, as well as Schedule A, Itemized Deductions. If you have a gain, it would go on Form 4684 as well, but would be reported on Schedule D, Capital Gains and Losses.
This is just a brief summary of what to keep in mind if you have a loss from a natural disaster; there are other items to consider when calculating a gain or loss. If you've been affected by a natural disaster, you have enough to worry about without sweating the tax implications. We're here to help you navigate all the decisions and paperwork.