Personal Property Losses - Difficult Situation or No Problem?
After the passage of a tax law in August 1993, the treatment of personal property losses in a disaster became less difficult to deal with on personal income tax returns.
(Unfortunately, these rules only apply to personal property losses for individuals and only for losses related to an individual’s principal residence that is damaged or lost in a Presidentially Declared Disaster.)
In the case where there is a “full” recovery of the loss related to personal property, the insurance proceeds do not have to be reported as taxable income and a detail computation of the loss of personal property does not have to be completed for tax purposes. The psychological impact as well as the need not to maintain detail records of the loss for a possible tax audit is a great benefit of this change.
This part of the law related to disaster situations has been in affect for over fifteen years. There is limited guidance from the IRS as to all of the property that is includable in this “pool” of assets for tax purposes.
Generally, it includes those items that would be found in “your” home. There might be items that you own that are not common, but are usual for your lifestyle. These will change over time. Twenty-five years ago, who would have thought that a computer would be a relatively common item found in a home? Today, there might be two or three in some homes.
Additionally, the fact that an item, generally associated with being in a residence is included even if, at the time of the loss, it was somewhere else that also was part of the disaster. If your gym clothes and equipment are at the office and both the office and the home are lost in a disaster, the gym clothes and equipment would be considered part of the personal property related to the residence.
If the taxpayer does not have insurance, the tax rules can be harsh in this area. The rules that are applied for tax purposes are quite different from those used for making a claim to an insurance company. The IRS position is that the computation of the loss related to personal items is computed based on the lower of your original cost or its lower fair market value (FMV) at the time of the loss (reflecting depreciation from use or obsolescence). Increases in fair market value (FMV) over the cost basis of antiques and other collectibles who’s FMV may increase will not affect the cost basis used for determining the amount of the loss for tax purposes.
This is the same rule that is applied to the dwelling, but in most cases, the dwelling has not decreased in value as of the date of the disaster compared to the purchase date.
In the case of the personal property, it is computed on each item individually. (For the dwelling it is computed on the structure as a whole.) Further, it is likely to be more difficult to determine the FMV of a five year old television set or a half used jar of jelly. As with the dwelling, the cost of repairs may assist in this determination for some items. The use of the lower of cost or FMV requires the determination of the decrease in FMV which may be difficult to determine. The method chosen must be used for all assets lost.
The IRS likes to apply "thrift store" values to personal property items. Many tax professionals believe this is not a fair method of valuation. The item had not been turned over to a thrift store because it had greater value to the taxpayer than the thrift store valuation. After the disaster, if the item was only damaged and not destroyed, it may be impossible to place a FMV on it in its damaged state.
In situations where the FMV has increased, the increase in one item cannot be used to offset the decrease in another item. Each item must stand on its own.
What about "sets" of items? What if three place settings of china out of twelve are destroyed? For insurance purposes it may have been possible to purchase a whole new set of twelve, if the pattern can no longer be found. But for tax purposes, the deduction might be limited to only that portion of the set actually lost. This is an area requiring judgment; however, taking an aggressive position in this area on a tax return can result in problems later if the return is audited by the IRS.
Another problem exists for those with insurance coverage on personal goods that are specifically itemized in their insurance policy. (Generally referred to as Scheduled Property) These are usually items that are covered on special floaters or scheduled in the insurance policy. Such scheduled property is treated in the same manner as the dwelling. In fact the tax law allows the scheduled property and the dwelling to be added together for purposes of reporting the “gain or loss” on the tax return. Thus if a taxpayer receives $200,000 for damage to the dwelling resulting from damages that occurred as part of a Presedentially Declared Disaster and $50,000 for a piece of scheduled property, all $250,000 may be used to repair the dwelling in order to qualify for deferral of any possible tax income arising from the receipt of the insurance money. If in addition to the $250,000 of insurance proceeds, the taxpayer receives $75,000 for unscheduled property, the taxpayer need not report any of these proceeds to the IRS on a tax return.
If the insurance proceeds are inadequate and a loss can be claimed, then the whole difficult process of reporting the loss, including identifying each item, its cost, fair market value before and after the event and the insurance proceeds must be calculated. If a loss results, it will be subject to other adjustments. Due to policy limits and restrictions some items may not be covered by the insurance claim.
The key is to carry insurance coverage that will compensate you adequately in the event of a loss.
In some cases the insurance company may actually replace the items. They may have access to sources that the general public is not aware of. If the items lost are simply replaced with items supplied by the insurance company, no tax reportable event has occurred as to these items because the items lost have not been converted into “cash.”