Tuesday, February 3, 2015



This article is part of a series of articles emphasizing several ways taxpayers can be trapped by problems in dealing with the tax reporting obligations resulting from a major casualty loss event.
In order to understand which errors are possible and their impact on taxpayers, it is necessary to start with the taxpayers’ insurance situation.
Here is the simple case. Regardless of the level insurance coverage, if at the end of the tax year event, although the claim is not completely settled (not all the claim has been paid), by the time the tax return is to be filed including the post-year-end information in the computations results in a settled transaction, the outcome is final; reporting information on the tax return for the year of the event is all available, the taxpayer has a completed transaction. This does not necessarily mean that mistake cannot be made. It simply reduces the spectrum of possible errors.
But, the above is the unusual situation. If the claim is not settled by the time the return is due, the taxpayer may have to wait until the next year to report the loss. This will be discussed in detail in another article, “REASONABLE PROSPECT OF RECOVERY.” But there should still be a disclosure of the event facts know as of the end of the relevant tax filing year. That aspect is discussed under the topic: “SOME MAJOR VAGUE PHRASES” in a later post.
Insurance (or the lack of insurance) impacts the tax consequences of disaster  events. The presence or lack of insurance must be considered in the overall evaluation of the loss event and its tax implications. Generally there are three possibilities.
Here are the general situations to consider:
No Insurance Coverage?
There may be situations that the loss is not covered by insurance, but it turns out was caused by some entity that may be pursued for reimbursement (a responsible third party). These situations present tax reporting concerns similar to insured losses. The an additional concern is that the third party responsible for the loss may not be evident for some time after the event; the decision to pursue a claim against that party may take several more months to conclude. In some cases, it may be difficult to find a necessary advocate to pursue the claim. Filing a return in these cases creates complications. When it comes to filing the return for the loss year the process may be in early decision stages; see “DON’T RUSH TO DEDUCT” in other articles on this blog.
Where a loss occurs that is not covered by insurance, the taxpayer has additional hurdles to cross. An event that is covered by insurance adds a level of the event being classified as a casualty because an insurance company is going to make a cash payment due to the loss (even if it is not adequate for a proper recovery). If the taxpayer simply elected not to purchase coverage, that is one thing, the Code does not require taxpayers to carry insurance for all possible events that include possible insurance coverage. But, the situation may present additional steps to determine if a “casualty” as defined by the Internal Revenue Code has occurred. For example, termite damage generally is not a casualty event since the damage occurs slowly, progressively. Similarly, drought is not usually considered a casualty. But, there are cases involving both termites and drought that have been were determined by courts to be casualties.
Where a loss occurs and is not addressed by the taxpayer, the court generally sees subsequent losses in the same area to not be deductible since the taxpayer was apparently not powerless to prevent the loss.
The documentation of the loss in these cases is extremely important. The lack of insurance removes an independent party evaluating the loss, even if the insurance company does not pay the appropriate amont.
Under-insured Coverage?
In the case of flood coverage, there is a maximum policy payout that often limits the loss recovery to an amount that is less than the total loss. In other cases, insurance may have been purchased on the basis of what premium was affordable rather than what coverage was needed. Taxpayers are not penalized by the tax law for these conditions. In many of these situations the tax consequences become apparent quicker due to the loss being so much greater than the coverage. As a result, the insurance may payout the maximum quickly leaving the taxpayer to compute the loss and possibly claim a loss.
For properties that have been held for some time the cost basis may be lower that the insurance payout. Even though the coverage is not adequate, the taxpayer has a gain with a short-fall in funds to pay for repairs.
Because of the many variables, these cases can be very difficult to arrive at how and when to report a loss or possible deferral.
Adequately Insured Coverage?
While a taxpayer may have adequate insurance, there are numerous situations where collection becomes problematic. Disagreements can arise between adjuster and property owner over the appropriate amount of reimbursement. There are cases where owners are attempting to get “pre-event” deferred maintenance covered by the insurance company and there are cases where the insurance adjuster attempts to take advantage of the owners’ lack of negotiation skills. In many of these cases where adequate insurance coveage exists, the extended collection process can be a problem for taxpayers. Where there is the possibility of not collecting the full amount of the covered loss there may or may not be resulting tax loss.

Where there is a Federal Disaster Declaration additional issues can arise.
In many wide-spread events, the insurance companies are stretched thin on providing timely adjustment services. This can stretch out the settlement process.
The taxpayer can elect to claim a loss on the income tax return for the year of the loss event or the immediately preceding year. But claiming the loss has additional issues that must be addressed. In some cases the event occurs near the end of the year and the Disaster Declaration is not announced until late in February or even into March of the following year. The decision to deduct a loss in the year of loss or the prior year becomes more stress laden. After 2005 Katrina and 2013 Colorado Flooding, the IRS extended the April 15 decision deadline to October 15. Katrina occurred in late August and the Colorado Flooding occurred in Mid-September. But Super Storm Sandy that hit in late October of 2012 and affected a number of states, but received no extension of the April 15 deadline to claim any loss on the prior year return.

JOHN TRAPANI assists both taxpayers directly and advises taxpayers’ tax professionals.
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.  

© 2015, John Trapani, CPA,
All rights to reproduce or quote any part of the chapter in any other publication are reserved by the author.


Certified Public Accountant

2975 E. Hillcrest Drive, #403

Thousand Oaks, CA 91362

(805) 497-4411       E-mail John@TrapaniCPA.com

Blog: www.AccountantForDisasteRrecovery.com

It All Adds Up For You

Tax Advice Disclaimer
Any implication of accounting, business or tax advice contained in this material is not intended as a thorough, in-depth analysis related to your specific issues. It is not a substitute for a formal opinion including a discussion or your specific situation. It is not sufficient to avoid tax-related penalties. If desired, John Trapani, CPA would be pleased to perform the requisite research, specific to your facts and circumstances and provide you with a detailed written analysis. Such an engagement would be the subject of a separate engagement letter letter that would define the scope and limits of the desired consultation services.
This material was completed on the date of the posting

A 450+ page text book is available for purchase:
DISASTER RECOVERY, Tax Benefits and Reporting Responsibilities
The book covers the tax reporting process from incident to resolution in disaster situations including descriptions of  how taxpayers can run into trouble.

An APPRAISER'S GUIDE (100 pages) is also available for purchase  to assist in evaluating appraisal reports and guiding appraisers in the tax law requirements to be addressed in an appraisal.

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