EARTHQUAKE: THE ROAD TO RECOVERY : Tax Deductions Can Help With Disaster Losses

The Internal Revenue Service can offer some relief to many Southland residents who suffered damage in October’s fires or January’s earthquake. The most important help is a tax deduction for disaster loss.

But you must do several things to qualify for this relief.

First, you must be able to prove your loss.

Second, your loss must not be compensated by insurance. If you have insurance, you can deduct only uncompensated losses on your tax return.

Third, you must itemize deductions on your tax return to claim non-business disaster losses. You cannot just claim the standard tax deduction.

Fourth, you can deduct only non-business disaster losses that exceed 10% of your adjusted gross income. The first $100 of loss is not deductible. (California also permits you to deduct disaster losses under rules similar to the federal rules. California also uses the 10% and $100 limits.)

Because President Clinton declared a national disaster in the January earthquake, you can deduct your loss on either your 1993 or 1994 tax return. You can deduct losses from the October fires on either your 1992 or 1993 tax return. If you want to claim fire losses in 1992 and have already filed your 1992 tax return, you can file an amended 1992 tax return on IRS Form 1040X; write “Southern California Fires” at the top of this tax return.

You may estimate your insurance reimbursements and repair costs in completing your 1993 return and then later correct the return using IRS Form 1040X. Also, the IRS will let you extend the due date of your 1993 tax return to Oct. 15, 1994.

Where your disaster loss exceeds your current income, you may carry back the excess loss three years to get refunds of prior years’ federal tax payments. If you still have some unused loss, you may carry it forward for up to 15 years. The process is complicated, and should be discussed with a professional tax preparer. (California also has carry-over rules, but they differ from the federal rules.)

What losses are covered? The disaster-loss tax deduction covers any physical damage caused by a disaster. Property damage from either the earthquakes or fires will qualify.

You can deduct breakage and other physical damage to buildings, to other structures, to furnishings, to cars and to other belongings. You also can deduct damage to landscaping. You can also deduct spoiled food.

You cannot deduct lost earnings or profits you suffered because of the earthquake or fires.

Also, you cannot deduct personal expenses resulting from the earthquakes or fires, or temporary housing or moving expenses. You cannot deduct medical expenses from earthquake or fire injuries as disaster-loss deductions, although they may be deductible under the regular medical-expense deduction.

And you cannot deduct the loss in value of your home because of the threat of future earthquakes or fires.

What happens if you do not repair or replace the damage? You are entitled to the deduction when the loss occurs. You do not have to fix the damage to claim tax deductions.

How do you prove your loss? The IRS may not just accept your claim that you suffered a $50,000 loss in the earthquake. You must prove what was damaged and how much damage you suffered.

Your tax deduction for earthquake damage to your home is the loss in value due to the earthquake. You could have an appraiser determine the value before and after the earthquake and subtract the two; the difference is your disaster loss.

However, most people will base their deductions on the cost of repairs. Take pictures of the damage. Get a good written estimate from a contractor, structural engineer or architect. Keep invoices when the work is done. Keep insurance claims and reports. These should be enough to get you through an IRS audit.

Remember that your loss is limited to the lesser of your property’s cost, or its fair market value before the disaster.

What happens if you lost dishes and glassware in the earthquake or furniture in the fire? Your loss may be more difficult to prove, but it still is tax-deductible if you can prove it. Take detailed pictures of the damage if you still can. Before and after shots will help in an IRS audit if you have them.

Keep receipts when you replace dishes, glassware, furniture, etc. Insurance inventories and reports also are good evidence for an audit.

You may have some tax deductions even if you were insured. Earthquake insurance policies have high deductible amounts and pay you only for damage above those limits. Uncompensated losses below those limits are tax-deductible. Also, you can deduct other damage not covered by your insurance.

Disaster losses (other than business losses) are an itemized tax deduction. Claim them on Schedule A (Itemized Deductions) to your tax return. This means you have to itemize tax deductions to claim a disaster loss.

Here’s an example:

Let’s say that you suffered a $100,000 loss, that you received $60,000 from your insurance company, and that your adjusted gross income is $50,000.

Your starting loss in filling out IRS Form 4684 (Casualties and Thefts) is $100,000. You reduce that loss by the $60,000 insurance payment to a $40,000 uninsured loss.

The first $100 of your loss is non-deductible. The $40,000 uninsured loss is reduced by $100, leaving a $39,900 loss.

You can deduct the $39,900 loss only to the extent it exceeds 10% of your adjusted gross income. Your adjusted gross income is $50,000, and 10% is $5,000, so subtract $5,000 from your $39,900 loss. That leaves a $34,900 loss.

You can claim that loss as an itemized tax deduction on Schedule A (Itemized Deductions) to your tax return. This disaster loss deduction is not subject to the 2% itemized deduction floor or the 3% adjustment to itemized deductions for tax returns reporting adjusted gross income in excess of $111,800.

The IRS is waiving penalties on tax returns filed late on account of the earthquake. Generally, penalties will be waived on tax returns due to be filed or amounts due between Jan. 15, 1994, and Feb. 28, 1994. Write “L.A. Earthquake” on top of these tax returns when you file them. Although penalties will be waived, interest on late payments will still be charged.

The IRS has several publications that are useful in determining disaster-loss tax deductions. You will need IRS Form 4684 (Casualties and Thefts). You also can get IRS Publication 547 (Nonbusiness Disasters, Casualties and Thefts), IRS Publication 584 (Nonbusiness Disaster, Casualty, and Theft Loss Workbook), and IRS Publication 334 (Tax Guide for Small Business) from the local office of the IRS or from the offices of the Federal Emergency Management Agency. You can also order them by calling toll-free (800) TAX-FORM (829-3676).

For additional tax information, you can call toll-free (800) TAX-1040 (829-1040), or you can visit an IRS office for walk-in help. Hours are Monday through Friday from 8 a.m. to 4:30 p.m. For Spanish-language assistance, you can call toll-free (800) 829-4672.