I live in the San Diego area where many residents suffered losses as a result of the fires that have struck our region in 2007. Our area and several other counties were declared a federal disaster area. If you are someone who has suffered a loss in a federally declared disaster area in 2007, this is how it could affect your income taxes.
Potentially the most critical tax issue kicks in if you are paid more by your insurance company than the tax basis (generally, the cost) of your property. In that case, you should spend all of the insurance proceeds to rebuild and replace the property. Reinvesting in this way will usually eliminate any tax issues relating to gains from the insurance proceeds. Being in a federal disaster area means that you have at least four years to reinvest.
Of course, many taxpayers had losses other than their homes, including vehicles, furniture and other items. Whatever it is that you have lost will be considered a casualty loss and may result in a tax deduction.
Here is how this works. First, you need to determine both the fair market value and the cost of that which you lost and use the lower number. Form 4684 is used to calculate your loss. This form will direct you to subtract $100 and any insurance proceeds. You must then reduce your loss further by 10% of your adjusted gross income. Finally, you will need to carry the remaining loss to Schedule A where it is treated as an itemized deduction. It only helps if you itemize. Obviously, overcoming these various thresholds stops most people from claiming a casualty loss unless it is significant.
Once you determine that you do have a deductible casualty loss as a result of the recent fires, you have a choice. Since this was a federally declared disaster, you will be able to claim the loss either on your 2007 or on an amended 2006 tax return. The idea is to get a tax refund back to you as soon as possible. Since it is near time to file for 2007 you may want to wait and be sure that you claim the deduction in the year that will result in the best tax advantage. Unfortunately, you cannot claim any loss until you know the final settlement.
If you are a business owner or investor, you may be able to take advantage of a special recent tax provision that applies only to those in a federally declared disaster. It allows you to use your insurance proceeds to purchase other types of property used in any productive trade or business. For example, an avocado farmer could use the insurance proceeds from the loss of his grove to start a pizza parlor.
The most distressing scenario is for those who bought their homes long ago and were underinsured when the fire struck. Over and above experiencing a devastating casualty loss, they will not have any tax relief either. This disaster is causing many of us to dig up our homeowner's policies and to make sure that we have adequate insurance coverage. It is also a reminder to maintain good records that include costs and photographic evidence of the many things that we own. Keeping this documentation safely off-site is essential.
