September 12, 2010
Victims of a savage hurricane, a flood, a tornado or some other major disaster aren’t likely to be thinking about the fine print of the Internal Revenue Code. But many should be doing exactly that. In some cases, it can be a surprisingly quick way to get financial relief.
Warning: As with so many tax breaks, the rules can be highly complex and there are stiff limits on deductions. To make matters worse, Congress still hasn’t decided whether it will resurrect a tax-law provision related to disaster losses that expired at the end of last year. Help from an experienced professional tax preparer may be in order.
Even so, it’s worth taking a refresher course on the basics — especially since one major break involves a bit of counterintuitive thinking — and the Atlantic hurricane season doesn’t officially end for nearly three months.
Here’s the general rule: Casualty losses usually are deductible in the year the casualty actually happened. That makes sense. If you have a loss during 2010, for example, you typically would claim it next year, when you file your tax return for 2010.
But there is an important and little-known exception to that rule. If you have a loss in a federally declared disaster area, you typically can deduct the loss either on your tax return for the year in which it actually occurred — or you can choose to deduct it on your return for the previous year. Losses this year, for example, can be claimed either on your return for 2010, to be filed next year, or on your return for 2009.
Those who have already filed a return for 2009, as most people have by now, can file what’s known as an “amended” return using Form 1040X, which is available on the IRS website. That could bring you badly needed cash much sooner than having to wait until after you file your 2010 return next year.
For example, the IRS recently said victims of severe storms and flooding beginning July 22 in parts of Illinois may qualify for special "tax relief" by deducting personal property losses “not covered by insurance or other reimbursements." The agency noted that claiming the loss on an original or amended return for last year "will get the taxpayer an earlier refund, but waiting to claim the loss on this year’s return could result in a greater tax saving, depending on other income factors."
You or your tax preparer may need to crunch the numbers both ways to figure out which year to choose. Special rules on federally declared disaster-area losses can make the calculations tricky.
Extending the ‘Net Disaster Loss’ Deduction
It isn't clear whether Congress will revive a tax-law provision that expired at the end of last year, which allowed taxpayers who take what's known as the standard deduction to increase that amount by a net disaster loss (after insurance and other reimbursements) from a federally declared disaster. Nearly two-thirds of all taxpayers claim the standard deduction each year, instead of itemizing their deductions.
Although extending this rule isn’t particularly controversial, it is part of other legislation that has become ensnared in political bickering as Election Day draws near. It’s possible that lawmakers will wait until after the November elections to act. Another possibility is that nothing will happen and this break will remain dead.
One big problem many victims face is reconstructing records that were destroyed during a disaster. This can be very time-consuming and burdensome, but it’s important to do so in case of a challenge by a skeptical IRS agent at some future date. Start by taking photos or videos as quickly as possible after the catastrophe to help document the extent of your losses. The IRS offers several other suggestions.
One final point to consider: Defining a casualty loss can sometimes be trickier than it sounds and has led to courtroom battles between taxpayers and the IRS. For the record, the IRS says a casualty loss "can result from the damage, destruction or loss of your property from any sudden, unexpected, or unusual event, such as a flood, hurricane, tornado, fire, earthquake or even volcanic eruption."
Sudden events refer to events that happen swiftly, rather than those that occur gradually or progressively. For more details, see IRS Publication 547.