A flood can wash out more than streets and sewers. It can also wash out a lot of wallets.
Illinois residents know that well. Since last summer’s floods, they have filed more than 44,000 applications for financial relief from the Federal Emergency Management Agency, reports Dave Skarosi, the FEMA coordinating officer for Illinois, and the agency has delivered nearly $60 million.
Now that the tax season is here, another federal agency, the IRS, may be able to provide a little disaster relief to storm survivors.
Taxpayers in federally declared disaster areas-38 Illinois counties, including McHenry, Lake and parts of Cook, were so designated-may find relief because of two parts of the tax law. One part allows storm victims to file amended returns for the year preceding the disaster and the second makes some insurance reimbursements non-taxable.
The provision allowing a taxpayer to amend his previous year’s return, in this case, the 1992 return, is helpful because it can provide a little extra cash just when he needs it most, explains Mike McGrail, an IRS representative in Chicago.
For instance, if a homeowner had reported a gross adjusted income of $50,000 on his 1992 return and suffered $150,000 damages because his walls caved in during the storm, he could deduct part of that loss from the $50,000 and file an amended 1992 return, possibly getting a refund quicker than if he waited until his 1993 taxes were due and claimed the loss then. (If a person elects to file an amended 1992 return, it must be filed by April 15, McGrail says.)
It sounds great, but there are a number of catches.
“It could be very complicated,” says Howard Feinstein, a certified public accountant in Wilmette who is a member of the Council for CPAs for the Public Interest, a charitable division of the Illinois CPA Society. “The people who kept their heads above water when the flood was occurring may now be drowning in paperwork.”
First of all, the taxpayer has to determine what exactly his loss is, Feinstein says. In theory, the loss is the market value of the property before the disaster minus the market value after it, as long as that amount doesn’t exceed what the person has invested in the house.
But who decides what the market value of the house is?
“A key item is getting appraisals,” explains Ken Strauss, a CPA in Miami who helped several of his clients claim disaster losses after Hurricane Andrew in 1992. An independent appraisal before and after a disaster is good evidence of loss, Strauss explains.
If a property owner doesn’t have a current appraisal, then he may have to turn to more typical forms of documentation to calculate his loss.
Videotapes or photographs showing what the property looked like before and after the disaster may be particularly helpful, Feinstein says. General paperwork about the house, such as information about the original purchase price and the costs of improvements, are key. Even receipts for large appliances and furniture may be needed, he says.
The fictional taxpayer in the example above has determined that his property was worth $200,000 before the storm and only $50,000 after. Can he claim a loss of $150,000?
Probably not, Feinstein says. First, he has to subtract any insurance reimbursement. But for the sake of discussion, let’s say this taxpayer’s policy didn’t cover flood damage.
Then the taxpayer has to make sure the loss doesn’t exceed the “cost basis” of his house, or the actual amount of money he has invested, Feinstein explains.
Let’s say his house cost $40,000 when he bought it 20 years ago, and he put $10,000 into a renovated kitchen. So his cost basis is $50,000. That’s the maximum amount he can claim, even though his actual loss was $150,000, Feinstein says.
Then the taxpayer has to subtract $100 from the adjusted loss, then 10 percent of his gross adjusted income, $5,000. That leaves him with a claimable loss of $44,900.
If he files an amended return for 1992, he’ll show a new adjusted gross income of only $5,100, certainly entitling him to a refund.
However, McGrail explains, filing an amended return might not be the most financially advantageous thing to do.
“It’s important to look closely at tax returns for both years,” he says. Since the loss is reduced by 10 percent of the gross adjusted income, the taxpayer would probably be better off claiming the loss in the year he had the lowest income, McGrail says.
Replacing house’s contents
In the above example, let’s say the homeowner was well insured against flooding and received enough money to replace everything, including the contents of his house.
In the past, that money would have to have been spent replacing exactly what was lost, says Strauss.
“The key was that if you received insurance proceeds you would have to list each piece of property and replace each item with a similar item to avoid being taxed,” he says.
Anna Maria Galdieri, a CPA in Oakland, recalls an instance where an art collector was reimbursed by insurance for several thousands of dollars worth of lithographs lost in the Oakland fire in 1991 and decided to replace them with watercolors.
The IRS ruled that he had to pay taxes on the reimbursement because it decided that lithographs weren’t “similar” enough to watercolors.
“We thought that was sort of ridiculous,” Galdieri says, “so we went to the national IRS office, which said . . . that if a taxpayer lost a phonograph and replaced it with a CD player, that was OK, but if he replaced it with a TV, he must realize a gain.”
Galdieri and others successfully pushed for legislation to change that narrow reading of the law, and now insurance reimbursements for household contents are non-taxable, so they can be spent on anything the disaster victim chooses. (That doesn’t include household items that were itemized on separate schedules to the insurance policy; insurance reimbursements for these items must be reinvested in similar items or the house itself or they will be taxed.)
The tax law also was loosened for federal disaster area victims in terms of real estate.
Normally, if a person sells his house or is reimbursed by insurance for a destroyed house, he has two years to spend the money replacing the house or buying a new one to avoid paying taxes on it. The law change extends that to four years for those living in a federal disaster area.
Even with the tax law changes, Galdieri, for one, says it’s still up to the individual taxpayer in a disaster area to fight for the best deal. “If you quote me on anything,” she says, “tell readers, `Don’t back down from the IRS.’ “
That’s surely good advice at any time, but the people who didn’t back down from the raging flood waters are going to be glad the IRS is presenting less formidable resistance than in past disasters.
