Hurricane Sandy, which struck the New York and Mid-Atlantic region on October 29 and 30, left a trail of destruction and dislocation. Numerous homes and businesses were either destroyed or severely damaged and the loss of electrical power and other infrastructure damage was widespread. This article examines the tax consequences of the physical losses sustained in the storm as well as the tax incentives and relief provisions available to those impacted by the storm.
Generally, individuals may not deduct losses with respect to property unless such property was used in a trade or business or in an activity entered into for profit. Therefore, losses sustained on the sale or exchange of a personal residence or other items of personal property cannot be deducted. However, the Internal Revenue Code allows taxpayers who suffer casualty losses with respect to such personal use property to deduct the amount of the loss in computing taxable income.
Code Section 165(c)(3) allows a noncorporate taxpayer to claim a casualty loss deduction, subject to applicable limitations, for losses to property arising from fire, storm, theft or other casualty even if the property damaged or destroyed is neither used in a trade or business nor held in a transaction entered into for profit. Losses incurred with respect to property used in a trade or business or held in a transaction entered into for profit are deductible under Sections 165(c)(1) or (2), without regard to causation.
Section 165(h) imposes two thresholds on the deductibility of casualty losses. First, Section 165(h)(1) disallows the deductibility of the first $100 of each casualty loss. Second, pursuant to Section 165(h)(2), casualty losses in excess of any gain recognized as a result of a casualty can be deducted only to the extent that the aggregate amount of such losses sustained by the taxpayer in the taxable year exceeds 10 percent of the taxpayer’s adjusted gross income for the year. Moreover, the amount of any casualty loss must be reduced by any insurance proceeds or other reimbursement collected by the taxpayer on account of such loss.
In computing the amount of a casualty loss with respect to property held in a trade or business or held in a transaction entered into for profit and which has only been damaged, the amount of deductible loss is the lesser of the adjusted basis of the property (original cost less depreciation plus improvements other than normal maintenance) or the decline in fair market value of the property caused by the casualty. If such business or investment property is totally destroyed, the deductible loss is not limited to the property’s fair market value but is instead allowed up to the amount of the property’s adjusted basis. The measure of the loss for personal use property, however, is always the lesser of the decline in fair market value of the property caused by the casualty or the adjusted basis of the property.
If the president designates an event as a “federally declared disaster,” as in the case of Hurricane Sandy, special casualty loss rules also apply. Under Section 165(k), the forced abandonment of a residence resulting from a federally declared disaster is allowed as a casualty loss if:
(1) the taxpayer’s residence is located in an area determined by the government to warrant federal assistance under the Disaster Relief and Emergency Assistance Act;
(2) the disaster makes the residence unsafe for use as a residence; and
(3) within 120 days after the declaration of the federal disaster, a state or local government orders the taxpayer to demolish or relocate the residence.
This rule is meant to cover taxpayers whose residences are not physically damaged, and thus would not qualify for the casualty loss deduction under the general rules, but whose residences are condemned because of a threat of further destruction or because their residences are otherwise rendered uninhabitable by the disaster.
Under Section 165(k), all losses sustained by the taxpayer in the disaster, not merely the loss to the residence, are treated as casualty losses and allowed to be deducted as a casualty loss on your tax return.
Qualified Disaster Treatment of Payments to Victims
Having been declared a federal disaster for purposes of Section 165, the Internal Revenue Service has also confirmed that Hurricane Sandy qualifies as a “qualified disaster” for purposes of the exclusion from income for qualified disaster relief payments pursuant to Section 139. Under Section 139, qualified disaster relief payments are defined by Section 139(b), as amounts paid:
(1) to or for the benefit of an individual to reimburse or pay reasonable and necessary personal, family, living or funeral expenses incurred as a result of a qualified disaster; or
(2) to reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replacement of its contents to the extent that the need for such repair, rehabilitation or replacement is attributable to a qualified disaster.
Qualified disaster relief payments include payments made by an employer or by a federal, state or local government, or an agency or instrumentality of those governments, in connection with a qualified disaster, in order to promote the general welfare.
However, the foregoing payments will be qualified disaster relief payments only to the extent any expense compensated by them is not also compensated by insurance or otherwise.
To further facilitate relief payments, the IRS also announced that the designation of Hurricane Sandy as a qualified disaster means that employer-sponsored private foundations may provide disaster relief to employee-victims in areas affected by the hurricane without affecting their tax-exempt status.
Postponement of Various Tax Filing and Payment Deadlines
The IRS also announced November 2 that it is postponing various tax filing and payment deadlines starting in late October for individuals and businesses located in certain designated counties, giving affected taxpayers until February 1 to file these returns and pay any taxes due. The postponed deadlines include those for fourth-quarter individual estimated tax payments, normally due January 15. Also postponed are the deadlines for payroll and excise tax returns and accompanying payments for the third and fourth quarters, normally due October 31 and January 31, respectively. The postponement also applies to tax-exempt organizations required to file Form 990 series returns with an original or extended deadline falling during this period.
The IRS announced that it will also abate any interest and late-payment or late-filing penalties that would otherwise apply for taxpayers located in designated areas. It is also waiving failure-to-deposit penalties for federal payroll and excise tax deposits normally due if the deposits are made by November 26.
The IRS also announced it is willing to work with any taxpayer who resides outside the disaster area but whose books, records or tax professionals are located in affected areas. Also, all workers assisting the relief activities in the covered disaster areas who are affiliated with a recognized government or philanthropic organization are eligible for relief. The IRS has told taxpayers who live outside of the affected area and think they may qualify for relief that they must contact the IRS at 866-562-5227.
Although millions of people suffered significant hardships and losses that can never be compensated, the code’s casualty loss and qualified disaster relief provisions should financially assist impacted taxpayers.
Mark L. Silow is the firmwide managing partner of Fox Rothschild. He formerly was chairman of the firm’s tax and estates department. His work involves a broad range of commercial and tax matters, including business and tax planning, corporate acquisitions and dispositions, real estate transactions, estate planning and employee benefits.