Friday, June 14, 2013

INSURANCE VALUATION AFTER CATASTROPHE?



INSURANCE VALUATION AFTER CATASTROPHE?


(A question asked recently of this blog)

It is important to understand that the valuation of your loss proposed by an insurance adjuster is only slightly related to a valuation that you would use for income tax purposes.

·         Yes, it is the same location.
·         Yes, hopefully it is the same property lost or damaged.
·         Yes, both are supposed to be dealing with values.

But there are many differences:

·         Some property losses are not fully covered by insurance
We see this with Hurricane Sandy. Most of the losses are covered only by flood insurance (a very specialized product with limits on the maximum amount of the coverage). The flood insurance policies often have nothing to do with the potential loss that might be suffered. We see this with earthquake insurance in California.
·         The insurance company has a goal of limiting its exposure.
o   Initially by limitations in the policy terms.
o   Then in the adjustment process.
(Why are they called “insurance claims adjusters?” Why does your claim need to be adjusted, and usually adjusted down?)
·         Some adjustments may be relevant due to policy limits.
One such normal policy limit applies to jewelry.
Your lost jewelry may have a value of $25,000, but your policy coverage is limited to only $5,000.
The uncovered value of $20,000 is still a loss.
The deduction value of that remaining value may be $20,000 or less.
·         The goal of the insurance valuation is to compensate you for your loss under the terms of the insurance contract.
There are many components to an insurance valuation. Not the least is the fact that the insurance company is attempting to pay as little as possible. There is usually a lot of negotiation that goes on in the process. Even in situations where the property has been totally destroyed, the insurance company may try to pay less than policy limits.
·         In many cases, the insurance is not adequate to cover the loss. The valuation stops at the policy limits, not the value of the loss.
·         Many people buy the amount of insurance that they can afford, not necessarily the amount they need. In other cases, the agent may sell the amount that will result in an immediate sale, in other words a low premium, in order to close the sale.
·         The insurance valuation may include costs that are part of the policy for items that bring the property to a better place than prior to the loss event. These items include building code upgrades that are required to be satisfied due to changes in the building code subsequent to the construction of the building. These code upgrades are not part of the loss using the cost of repairs method.
·         Due to other modifications that the owner may initiate as part of the actual repairs, some betterments may be incorporated into the repairs as part of a well thought out repair process that incorporates new building methods and materials.
For example, maybe a solar electrical and water heating systems is incorporated into the repairs instead of replacing existing systems. These costs would not be part of the cost of repairs for income tax deduction purposes. The taxpayer may be making a good financial decision, but it does not meet the tax code requirements.

In the best of circumstances, the insurance valuation is an estimate of the cost of repairs. If that valuation is used for taxes two elements come into play.
·         The Internal Revenue Code allows the use of the “cost of repairs” for determining a loss. If the insurance covers the estimated cost of repairs, there is no loss.
·         As has been discussed in many different ways on this blog, you cannot claim a loss using the cost of repairs method unless the repairs are actually made.
The loss is claimed on the return for the year in which the repairs are completed, not necessarily the year of the event.

For the preferred method of arriving at the economic loss, see many blog posts on the subject of using the Appraisal Method of computing the economic decline in value as part of determining a potential income tax deduction for a disaster loss.


Date Posted

Blog Topic (as of December 31, 2012)



4-29-2013

OTHER DSASTER APPRAISAL QUESTIONS
4-5-2013

APPRAISAL VALUATION ISSUES IN A CATASTROPHIC LOSS SITUATION
3-15-2013

COST OF REPAIRS COMPARED TO APPRAISAL METHOD OF DETERMINING THE VALUE OF A CASUALTY LOSS
11/21/2011

WAS IT A CASUALTY LOSS OR AN INVOLUNTARY CONVERSION GAIN
5/27/2011

Why is the Cost of Repairs Method of Loss Valuation not the one to use?
6/18/2008

FIGURING THE LOSS – MARKET VALUE METHOD


Finally, see a very important blog post: “Don’t Rush to Deduct” – September 12, 2011.


This blog, “AccountantForDisasterRecovery.com” has been addressing taxpayer income tax issues related to catastrophic losses for more than five years.
All rights to reproduce or quote any part of the chapter in any other publication are reserved by the author. Republication rights limited by the publisher of the book in which this chapter appears also apply.


JOHN TRAPANI


Certified Public Accountant


2975 E. Hillcrest Drive #403


Thousand Oaks, CA 91362


(805) 497-4411


Contact us through our website at:




Blog: www.AccountantForDisasteRrecovery.com


                                                                                                                      
                           It All Adds Up For You                     


  

This material was contributed by John Trapani. A Certified Public Accountant who has assisted taxpayers since 1976, in analyzing and reporting transactions of the type covered in this material.  
Internal Revenue Service Circular 230 Disclosure
This is a general discussion of tax law. The application of the law to specific facts may involve aspects that are not identical to the situations presented in this material. Relying on this material does not qualify as tax advice for purpose of mounting a defense of a tax position with the taxing authorities
The analysis of the tax consequences of any event is based on tax laws in effect at the time of the event.
This material was completed on the date of the posting
© 2013, John Trapani, CPA,






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