Refund Can Ease Storm’s Drain

With a little effort, you may be able to deduct some costs of El Nino damage from your taxes.

If El Nino wreaked havoc with your property--leaving you with substantial uninsured losses from floods or mudslides--you should know that Uncle Sam may be able to help.

Casualty losses--those arising from sudden, unusual and unexpected events, such as fires, floods, earthquakes and tornadoes--are not only tax deductible, if you live in a federally declared disaster area, but can be claimed in the year it happened or for the previous year.

Hundreds of people living in the 27 counties in California that were declared disaster areas because of El Nino-related storms may be able to get a tax refund--now when they need the money--even if the loss occurred in 1998.

But claiming casualty losses is never easy.

That’s partly because it’s up to you to establish the size of your loss. There are two ways to do this. First, you can determine the cost of repairs that are not covered by insurance. In other words, you list things you lost and what you paid to replace them. The second way is establishing the scope of the loss by comparing the appraisal on your property prior to the disaster with an appraisal afterward, claiming the decline in value as your loss.

But if you live in a property that has appreciated a great deal since you bought it, you should know that your tax-deductible loss can never exceed the amount you paid for the property. For example, let’s say you live in a house in Malibu that you bought for $50,000 in 1970 and today is worth more than $500,000. If you sustain $100,000, the maximum casualty loss you can claim is $50,000.

There’s a second step too. If you’re smart, you determine whether you can get a bigger bang for your buck by claiming the loss for the 1997 tax year, which could allow you to get a tax refund to help offset current repair costs, or by waiting until the 1998 return to make your claim.

Determining which year hinges on one thing: The size of your loss compared with your taxable income. That’s because casualty losses are limited: You can only claim them to the extent that they exceed 10% of your adjusted gross income plus $100.

For instance, if you had adjusted gross income of $50,000 and a $10,000 casualty loss, you would be able to deduct just $4,900 of the loss. That’s $10,000 minus 10% of your adjusted gross income ($5,000), minus $100.

Because that’s such a high threshold, taxpayers are wise to consider taking the loss in the year that their AGI is lowest. For instance, if you earned $45,000 in 1997, but expect to earn $50,000 in 1998, you’ll get $500 more in casualty loss deductions if you take the casualty loss for 1997.

However, if you are able to manage your adjusted gross income through sage use of employee benefit plans, you might be able to get a better tax answer by waiting.

Here’s why: Adjusted gross income is the income you report on the final line of the front page on your 1040. It is boosted by wages, tips, dividends and capital gains and reduced by contributions to tax-favored retirement accounts, such as 401(k) plans and deductible IRAs.

You cannot reduce your AGI through itemized deductions. But you can reduce it by contributing to a spectrum of employee benefit plans, when they are offered to you at work. There are three employee benefits that can have a significant impact: 401(k) plans, dependent-care accounts and so-called health-care spending accounts.

In all three cases, these plans allow you to save a set amount of your pretax income in a dedicated account. The 401(k), as most people know, is dedicated to funding retirement. If you withdraw funds prior to retirement, you pay tax and penalties. So you can’t put more in these accounts than you can afford to live without for a fairly substantial period.

However, the dependent-care and health-care spending accounts are for immediate expenditures. You can contribute up to $5,000 per year to a dependent care account, if you pay day-care expenses for a child or disabled adult so that both you and your spouse (when applicable) can work or attend school. Then, as you incur day-care expenses, you bill the account and it pays your baby sitter, nurse or child-care center. But because the money comes out of your paycheck before taxes are computed, you save federal income tax dollars on every dollar you contribute. So, a family in the 28% federal tax bracket saves $1,400 in federal income tax by paying $5,000 in day-care expenses through the account, rather than by personal check.

Health-care spending accounts are similar, however the money set aside is dedicated to paying nothing but unreimbursed medical expenses that you incur in that year. (Never contribute more than you’ll use in a year, because any money left in dependent-care and health-care spending accounts after year-end is lost.)

These contributions reduce your taxable income for purposes of determining your casualty loss threshold, as well as other deduction thresholds that now permeate the U.S. Tax Code.

In simple terms, a person who puts $5,000 in a 401(k), $5,000 in a dependent-care account, and $1,000 in a health-care spending account, boosts his other potential casualty loss deduction by $1,100.

Want more information on claiming casualty losses? The California Society of Certified Public Accountants offers a booklet of financial and tax advice for disaster victims. You can get a free copy of “Picking Up the Pieces” by calling (800) 9-CAL-CPA. When the recording answers, punch 3. The booklet is also posted on the group’s web site at https://www.calcpa.org

Kathy M. Kristof is a syndicated financial columnist and author of “Kathy Kristof’s Complete Book of Dollars and Sense.” Write to her in care of Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail [email protected]