18.3 Disaster Losses
If you suffer a loss from a disaster in an area declared by the President as warranting federal assistance, you may deduct the loss either on the return for the year of the loss or on the return of the prior tax year (18.13).
You may elect to claim the deduction on a tax return for the previous year any time on or before the later of (1) the due date (without extensions) of the return for the year of the disaster or (2) the due date considering any extension for filing the return for the prior tax year. For a 2012 disaster loss, you generally have until April 15, 2013, to amend a 2011 tax return to claim the 2012 loss for 2011. In the case of a 2013 disaster loss, you generally have until April 15, 2014, to amend a 2012 tax return to claim the 2013 loss for 2012.
Revoking prior year election.
You have 90 days in which to revoke an election to deduct a disaster loss for the previous year. After the 90-day period, the election becomes irrevocable. However, where an early election is made, you have until the due date for filing your return for the year of the disaster to change your election. Your revocation of an election is not effective unless you repay any credit or refund resulting from the election within the revocation period. A revocation made before you receive a refund will not be effective unless you repay the refund within 30 days after you receive it.
Homeowners forced to relocate.
If you were forced to relocate or demolish your home in a disaster area, you may be able to claim a loss even though the damage, such as from erosion, does not meet the sudden event test (18.1). For example, after a severe storm, there is danger to a group of homes from nearby mudslides. State officials order homeowners to evacuate and relocate their homes. Disaster loss treatment is allowed provided: (1) the President has determined that the area warrants federal disaster relief; (2) within 120 days of the President’s order, you are ordered by the state or local government to demolish or relocate your residence; and (3) the home was rendered unsafe by the erosion or other disaster. The law applies to vacation homes and rental properties, as well as to principal residences.
If these tests are met, the loss in value to your home is treated as a disaster loss so that you may elect to deduct the loss either in the year the demolition or relocation order is made or in the prior taxable year.
Fiscal year.
If you are on a fiscal year, an election may be made for disaster losses occurring after the close of a fiscal year on the return for that year. For example, if your fiscal year ends June 30, and you suffer a disaster loss at any time between July 1, 2011, and June 30, 2012, you may elect to deduct it on your return for the fiscal year ending June 30, 2011.
Disaster relief grants and loans.
Cancellation of part of a federal disaster loan under the Robert T. Stafford Disaster Relief and Emergency Assistance Act is treated as a reimbursement that reduces your loss (18.16). If you receive a post-disaster grant under the Disaster Relief Act to help you meet medical, dental, housing, transportation, personal property, or funeral expenses, the grant is excludable from income. However, to the extent the grant specifically reimburses a casualty loss or medical expense (17.2), that expense is not deductible. Unemployment assistance payments under the Disaster Relief Act are taxable unemployment benefits (2.6).
Law Alert
Disaster grants for business property losses.
Payments by the federal government or a state or local government to a business for property losses may not be excluded from business gross income. The IRS has ruled that the disaster relief exclusion that applies to government payments made to individuals to promote the general welfare does not apply to business property losses. The business realizes a taxable gain to the extent the grant exceeds the adjusted basis in the damaged or destroyed property, but that gain can be deferred under the involuntary conversion rules (18.19) by making a timely reinvestment of the payments in qualified replacement property. The replacement period for damaged or destroyed business property is two years (18.22).
IRS interest abatement.
For declared disasters, the IRS will abate interest on taxes due for the period covered by an extension to file tax returns and pay taxes.
Planning Reminder
Insurance Proceeds for Damaged or Destroyed Residence
Destruction of principal residence and contents.
Generally, you have a taxable gain if you receive insurance proceeds in excess of your adjusted basis for damaged or destroyed property (18.19). However, where your principal residence is destroyed, any gain from the receipt of insurance proceeds may generally be excluded from gross income under the $250,000 ($500,000 if married filing jointly) home sale exclusion (29.1). According to the IRS, a principal residence must be completely destroyed to qualify for the home sale exclusion; a partial destruction does not qualify. If a residence is damaged to the extent that the remaining structure must be deconstructed in order to rebuild, or the costs of repair substantially exceed the pre-disaster value of the home, the home is considered to have been completely destroyed, allowing the gain to be excluded from income subject to the $250,000/$500,000 exclusion limit. If the home sale exclusion is not available to you or if the gain exceeds your exclusion, the nonexcludable gain may be deferred under the involuntary conversion rules if you buy a replacement residence (18.19).
Filing Tip
Where your principal residence is damaged or destroyed in a federally declared disaster, favorable involuntary conversion rules eliminate tax on some of the gain and make it easier to defer the balance. These rules apply to renters as well as home owners.
Sale of land underlying destroyed principal residence or second home.
If your principal residence is destroyed in a federally declared disaster, and you decide to relocate elsewhere and sell the underlying land, the IRS treats the sale and the destruction as a single involuntary conversion. If you have a gain that is not excludable under the home sale exclusion rules (Chapter 29), the land sale proceeds are combined with your insurance recovery for purposes of figuring deferrable gain under the involuntary conversion replacement rules (18.19). All of the gain resulting from the insurance recovery may be deferred if a new principal residence is purchased within the four-year replacement period and it costs at least as much as the combined insurance and sales proceeds. The replacement period ends four years after the close of the first year in which any part of your gain is realized. The replacement period is extended from four years to five years if the destroyed principal residence was located in the Hurricane Katrina disaster area, Kansas disaster area, or Midwestern disaster area, provided that the replacement residence is in the respective disaster area.
The above “single conversion” rule also applies if a second residence such as a vacation home that qualifies for a mortgage interest deduction (15.1) is destroyed, but in that case the replacement period (18.22) is two years (instead of four years), unless the five-year replacement period for residences in the Hurricane Katrina disaster area, Kansas disaster area, or Midwestern disaster area applies.
Note: The IRS treats the sale of land and destruction of a residence as a single involuntary conversion even if the destruction was not in a federally declared disaster area. In this case, a two-year (rather than four-year) replacement period applies.