written by Jay Logal
On May 22, 2011 many people in our area experienced not only a devastating tornado, but also a tax event. No matter how painful or traumatic the events of that day were, we as a community, individuals and organizations must rebuild and move forward. Part of the moving forward process is the preparation and filing of our income tax returns. It is important to begin planning as soon as possible in order to place yourself into an advantageous tax position and understand the limits within which you must operate.
The people who had property damaged or destroyed have suffered an involuntary conversion in the eyes of the IRS. An involuntary conversion happens when property, as a result of its destruction in whole or in part is involuntarily converted into similar property or into money. This could result in a casualty loss, or for those tax payers receiving insurance benefits, it is also possible to have a casualty gain.
There are several situations that may occur in regard to your personal residence. Rebuilding your home or replacing your home will result in no gain being recognized from insurance proceeds. Since we are in a presidentially declared disaster area the time limit for replacing your home is extended to four years instead of the above mentioned two years. The decision not to replace your home will not necessarily result in recognition of gain.
If you decide to replace your home, but still own the land your destroyed home was built on, the sale of the vacant land within four years will be considered part of the original involuntary conversion. Being in a presidentially declared disaster area also provides the benefit that no gain is recognized for insurance proceeds on personal property, such as furniture, automobiles and jewelry. An additional benefit is that during the period in which your home is being rebuilt or replaced, you can continue to deduct home mortgage interest (provided it is rebuilt within four years).
Take the case of Robert. His home was destroyed and he lost everything. Robert’s insurance paid him more then he originally paid for his home, but because of his circumstances, he does not have a casualty gain to report. Additionally, even though Robert and his family live in a rental home while his home is being rebuilt, he will still deduct his home mortgage interest he pays.
In the case of uninsured property an individual can deduct as a casualty loss the cost of his residence and personal property. The amount of an individual’s casualty loss is limited by ten percent of their “adjusted gross income”. In the case of someone who lost their home, they will likely exceed that amount. It may be more difficult for a tenant who lost only personal property to exceed that amount.
Everyone’s tax situation is different. Those differences combined with our complicated tax code makes applying general information to specific situations difficult. The above general information is not meant to provide you with specific tax advice, but rather to encourage you to prepare yourself for your specific situation.
If you have any questions about involuntary conversion, please contact us today.