A “disaster” is defined in one dictionary as “a calamitous event, especially one occurring suddenly and causing great loss of life, damage, or hardship, such as a flood, or an airplane crash.”
The word “disaster” cannot convey the mental and physical anguish that results from such a “calamitous event.”
During times of widespread disaster, people turn for help to friends and family, to fellow citizens, or to caring individuals and charitable organizations throughout the world. When disaster strikes in the U.S., some may even turn to certain U.S. government agencies for monetary or other help. What many might find surprising is that even the IRS may be able to provide some form of disaster relief.
Primary IRS disaster relief
The IRS provides general casualty loss tax relief to individuals and businesses that suffer personal or singular tragedies, such as devastating fires, thefts, vehicle accidents, etc. To help ease the pain associated with the widespread devastation caused by a federally declared disaster, however, the IRS provides extra special treatment. A federally declared disaster is a disaster that occurred in an area declared by the President to be eligible for federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. It includes a major disaster or emergency declaration under the act.
In the case of federally declared disasters, the IRS provides preferential treatment for:
- Certain disaster payments received,
- Certain disaster area losses, and
- Certain gains on property located in a disaster area.
Disaster payments received. In many instances, funds that are received from a third party are treated as taxable ordinary income upon receipt. It is good to know, however, that the IRS specifically excludes from income certain payments received as a result of a disaster.
Post-disaster relief grants received under the Robert T. Stafford Disaster Relief and Emergency Assistance Act are excluded from income if the grant payments are made to help meet necessary expenses or serious needs for medical, dental, housing, personal property, transportation or funeral expenses. Note that casualty losses or medical expenses cannot be deducted to the extent they are specifically reimbursed by these disaster relief grants. Similarly, if part of a federal disaster loan was canceled under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, it is considered to be reimbursement for the loss rather than income from the cancellation of indebtedness. Take into consideration that this cancellation will reduce a casualty loss deduction, however.
Qualified disaster mitigation payments made under the Robert T. Stafford Disaster Relief and Emergency Assistance Act or the National Flood Insurance Act (as in effect on April 15, 2005) are also excluded from income. These are payments a property owner receives to reduce the risk of future damage to the property. The property owner cannot increase basis in the property, or take a deduction or credit, for expenditures made with respect to those payments.
In a similar manner, qualified disaster relief payments are excluded from the income of individuals to the extent any expenses compensated by these payments are not otherwise compensated for by insurance or other reimbursement. These payments are not subject to income tax, self-employment tax or employment taxes (social security, Medicare and federal unemployment taxes). In addition, no withholding applies to these payments.
Qualified disaster relief payments include payments received, regardless of the source, for the following expenses:
- Reasonable and necessary personal, family, living or funeral expenses incurred as a result of a federally declared disaster;
- Reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence, whether rented or owned, due to a federally declared disaster; and
- Reasonable and necessary expenses incurred for the repair or replacement of the contents of a personal residence due to a federally declared disaster.
Qualified disaster relief payments also include amounts paid by a federal, state or local government in connection with a federally declared disaster to individuals affected by that disaster.
Qualified disaster relief payments do not include:
- Amounts received for expenses otherwise paid for by insurance or other reimbursements, or
- Income replacement payments, such as payments of lost wages, lost business income or unemployment compensation.
Similarly, a grant that a business receives under a state program to reimburse businesses for losses incurred for damage or destruction of property because of a disaster is not excludable from income. However, the business may choose to postpone reporting gain realized from the grant if it buys qualifying replacement property within a certain period of time.
Disaster area losses. Not all folks are lucky enough to receive disaster payments sufficient to compensate them for property lost in the disaster. In such instances, there are special rules that apply to federally declared disaster area losses that may help mitigate the damage.
Usually, a casualty loss is only deducted in the year in which the casualty ocurred. Thus, the victim of the loss must wait until the end of the tax year to file a return for the year of loss and hopefully claim a tax refund related to the loss. This assumes that the victim has been able to generate sufficient other income and tax payments for the year of the loss to enable the claim of a tax refund, which isn’t always likely when there has been a widespread disaster in a particular area.
A federally declared disaster loss can be immediately carried back and reported on an amended Form 1040X if desired. This will often result in an almost immediate tax refund assuming the usual case in which taxable income and tax payments were higher for the year prior to the year of disaster.
If a home is located in a federally declared disaster area, and the state or local government orders it to be torn down or moved because it is no longer safe due to a federally declared disaster, the loss in value is treated as a casualty loss from a disaster.
Disaster gains postponed. In many instances, funds that are received as a result of a disaster could end up generating taxable income through the realization of gain on the “disposition” of an asset lost or consumed in the disaster when the funds that are received to replace those assets exceed the taxpayer’s basis in the asset. For example, the taxpayer may realize gain when he receives a $300,000 check to replace his devastated home if the home had a basis to him of 100,000, for example. The same would be true if the home was purchased for $100,000.
The IRS provides generally applicable rules for the postponement of certain gain realized as the result of reimbursements for property lost or destroyed. To postpone reporting gain, replacement property worth a particular amount must be purchased within a specified period of time. The replacement period begins on the date the property was damaged or destroyed and, in most instances, ends two years after the close of the first tax year in which any part of the gain was realized. In the case of gain on a main home located in a federally declared disaster area, however, this two-year period is stretched to four years. Further, the replacement period is actually beyond that four-year mark for some particular disaster areas.
Other IRS disaster relief
In the case of taxpayers affected by federally declared disasters, the IRS can also provide help in the form of providing prior year tax returns that may be needed to claim insurance reimbursement or government benefits available in a more cost effective manner (i.e., free vs. the usual fee to acquire the returns). Further, the IRS provides assistance in the form of delayed deadlines and lessened penalties for affected taxpayers.
While you know that you can count on a few good friends or family to help you muddle through after a federally declared disaster, and you hope that you can count on certain government agencies to also provide help, it is good to know that even the IRS is in your corner and waiting to provide assistance.