Disaster tax tips: roadmap of changes to tax code.

• Author: Galdieri, Anna Maria
• Position: DISASTER RELIEF

The inadequacy of many disaster-related federal tax regulations became apparent after the 1991 Oakland firestorms. As affected communities began to pick up the pieces, they also fought to reform several areas of the tax code. Much of the work done to help the Oakland fire victims gave those affected by the Southern California fires in October 2003 clear guidance on many of the issues they face in rebuilding.

In the wake of wildfire season, the following disaster-related tax issues can help reduce the burden on disaster victims--and ensure that the CPAs advising them achieve the desired tax results.

FEMA APPRAISAL

Uninsured disaster victims can use the Federal Emergency Management Agency appraisal of their loss to document their tax loss, a code section that was enacted after the Northridge earthquakes of 1994 [Sec. 165(i)(4)]. No loss can be taken until reimbursement claims have been settled.

THE MEASURE OF THE LOSS

The measure of the loss is the lesser of the decline in fair-market value or adjusted basis, not replacement cost.

Insured disaster victims often present me with a list of household contents they have valued at replacement cost because that is the number the insurance company uses. While the IRS will want to limit the value to thrift store values, the courts have allowed taxpayers to rebut that assumption and prevail.

REPLACEMENT COST

Insured disaster victims may have an economic loss if their insurance companies won't settle with them for the replacement cost of their real and personal property. They generally don't have a tax loss because the depreciated value of their contents is less than their insurance proceeds. Policy reformation is possible and disaster victims should work with organizations such as CARE and United Policy Holders to ensure a fair settlement.

SEC. 121 EXCLUSION

Homeowners who are insured and lose their principal residence in a federally declared disaster area can take their Sec. 121 exclusion against the gain realized. The money they receive for their contents is tax exempt [Sec. 1033 (h)(1)].

Many Southern California disaster victims are married and proposed insurance recoveries are less than $500,000. Since the exclusion wipes out the gain, when disaster victims rebuild or purchase a replacement home, their tax basis is equal to their replacement cost. If disaster victims sell their replacement home within two years of purchasing or rebuilding it, their gain is only the appreciation that's occurred...