Casualty Losses May Significantly Reduce Federal Income Taxes

Hurricane Ike inflicted a steep penalty on the Texas Gulf coast. However, there is an inconspicuous benefit ? casualty loss tax deductions. Taxpayers may be able to take a 2008 deduction if either personal or business property was damaged by Hurricane Ike.

Some taxpayers will be able to completely eliminate their 2008 federal income taxes by utilizing a casualty loss deduction. Even if insurance proceeds completely reimburse the cost of construction, the taxpayer likely qualifies for a substantial write-off. This is a generous tax benefit for those affected by a casualty.

What is a Casualty Loss?

A casualty loss is damage, destruction or loss of property from any sudden, unexpected and unusual event. Casualties can include fire, flood, hurricane, tornado, and earthquakes.

The casualty loss is calculated as follows: market value of property immediately before the casualty, less the sum of: a) market value immediately after the casualty and b) insurance proceeds.

For a major casualty such as Hurricane Ike, in a presidentially-declared disaster area, the deduction can be used in either the current or preceding tax year. Discuss your tax situation with your CPA or tax return preparer.

I'm Insured. Do I Qualify?

A frequent misconception is the owner of insured property does not qualify for a casualty loss. This simply is not true. Even if insurance proceeds fully fund restoration, the owner probably qualifies for a casualty loss. The casualty loss is really only subject to casualty loss limitations ($100 per casualty and in excess of 10% of adjusted gross income for personal-use property).

Issues to Consider for Casualty Losses

Casualty loss involves more than the physical property that was damaged. Other issues to consider when calculating the overall losses include market value, entrepreneurial profit, holding costs, time to rebuild, and time and cost to lease the vacant space.

Market value is the price for which property would sell, assuming reasonable exposure to the market and other key factors.

Entrepreneurial profit is the compensation required for an investor to assemble and coordinate labor, capital and assets.

Holding costs depend on the specific property and circumstances. For income properties closed because of a casualty, the lost revenue and cost to replace tenants would reduce the market value of the property after the casualty.

Time to rebuild includes the time it takes to settle your claim with your insurance company, which could take anywhere from three to 12 months, and the time it takes to contact and schedule a qualified company to do the rebuilding.

The time and cost to lease the vacant space includes revenue lost while space is renovated and leasing commissions and tenant improvements.

Determining the Casualty Loss

Obtain an appraisal from a qualified appraiser. For real estate, it should be a real estate appraiser. For commercial real estate, confirm the appraiser's experience with commercial real estate appraisals.

The appraisal should provide a value for the property: 1) immediately before the casualty and 2) immediately after the casualty. The valuation after the appraisal should consider issues which would impact the property including: 1) costs of renovation, 2) entrepreneurial profit, 3) lost rents prior to the property returning to stabilized occupancy, 4) tenant improvements, 5) leasing commissions, and 6) potential stigma. Depending on the level of destruction, the level of business activity in the area could decrease. This could reduce the level of business for either residential or commercial properties. The issue is not if the level of business decreases after the casualty. The issue is the perception immediately after the casualty.

Conclusion

Natural disasters bring much heartache, pain and financial distress. Congress has provided specific tax benefits for those suffering casualty losses. It is prudent and responsible to reduce your taxes with this clear-cut source of tax relief.

About O'Connor & Associates

O'Connor & Associates, a Houston-based national real estate service firm providing appraisals, market research, valuation, and federal and ad valorem tax reduction services, has been in business since 1974 and has more than 60,000 clients.

O'Connor & Associates, a Houston-based national real estate service firm providing appraisals, market research, valuation, and federal and ad valorem tax reduction services, has been in business since 1974 and has more than 60,000 clients.

The appraisal division of O'Connor & Associates is a national provider of investment real estate appraisal services including , , commercial real estate appraisals, commercial comparable sales database, condemnation appraisals, due diligence, residential appraisals and investment hypotheses.