IRS Provides Safe Harbors for Additional Hurricane Relief
For taxpayers still reeling from the devastation of 2017’s round of natural disasters, the IRS has issued additional guidance to help lessen the burden this tax season. Effective December 13, 2017, Revenue Procedure 2018-08 provides several safe harbor methods taxpayers may use to estimate the decrease in their property’s fair market value (FMV). In general, this decrease in FMV is compared to the property’s cost basis, and the lesser represents the casualty loss that will be reported on the tax return.
In addition, effective August 22, 2017, Rev. Proc. 2018-09 provides a cost index safe harbor method that gives taxpayers affected by the 2017 hurricanes several scenarios to apply to their situations. The IRS has issued new casualties and thefts forms for 2016 and will have 2017 forms available in time for the upcoming filing season. Keep in mind these revenue procedures are applicable to tax years 2016 and 2017 and supplement the relief previously granted by the IRS and the Disaster Tax Relief and Airport and Airway Extension Act of 2017 signed on September 29, 2017, by President Donald Trump. While this additional guidance is helpful, it still requires a solid understanding of the Internal Revenue Code.
Definition of Applicable Property
It’s important to understand what types of property are covered under these revenue procedures. The two applicable property categories are personal-use residential real property and personal belongings. Personal-use residential real property consists of real property owned by a taxpayer, e.g., buildings, ornamental trees and shrubbery, but excludes property used as a rental property, containing a home office or used in a trade or business to make a profit. Personal-use residential real property must contain a personal residence.
Personal belongings are tangible personal property not used in a trade or business. This excludes boats, aircrafts, mobile homes, trailers, vehicles or an antique or other asset that maintains or increases its value over time.
Reduction for No-Cost Repairs
Taxpayers who elect to use a safe harbor method to determine their casualty loss must reduce the loss by the value of any no-cost repairs completed either by volunteers or for a de minimis amount.
Safe Harbor Methods Applicable to All Taxpayers
All taxpayers who suffered a casualty loss, including those in a federally declared disaster area, may use the following safe harbor methods to determine the decrease in their property’s FMV:
Estimated Repair Cost Safe Harbor Method (Personal-use residential property only)
Under this method, the taxpayer would use the lesser of two repair estimates obtained from two separate and independent licensed contractors. Estimates must include itemized costs to restore the property to the condition existing immediately prior to the casualty. This method is available for losses of $20,000 or less, as determined prior to any applicable limitations.
Insurance Safe Harbor Method (Personal-use residential property only)
Taxpayers may estimate their loss using reports prepared by their homeowners or flood insurance companies. This method may be used if the reports include the estimated loss sustained to the taxpayer’s personal-use residential real property.
De Minimis Safe Harbor Method (Personal-use residential property and personal belongings)
The taxpayer may make a good-faith estimate—and must maintain records detailing the methodology used—of the decrease in FMV of the taxpayer’s property. This method is separately available to personal-use residential real property and personal belongings losses up to $5,000, prior to any other applicable limitations.
Safe Harbor Methods Applicable ONLY to Taxpayers in Federally Declared Disaster Areas
Taxpayers who suffered a casualty loss in a federally declared disaster area may use the following safe harbor methods:
Contractor Safe Harbor Method (Personal-use residential property only)
With a signed and binding contract from an independent, licensed contractor, taxpayers may determine the decrease in the FMV of their personal-use residential property. The contract must include estimates containing the itemized costs to restore the property to the condition existing immediately prior to the casualty.
Disaster Loan Appraisal Safe Harbor Method (Personal-use residential property only)
An appraisal prepared for the purpose of obtaining a loan of federal funds or a loan guarantee from the federal government may be used in determining the decrease in FMV of a taxpayer’s personal-use residential real property.
Replacement Cost Safe Harbor Method (Personal belongings only)
Taxpayers may use this method to determine the decrease in FMV of their personal belongings affected by a federally declared disaster. First, using the table below, they must determine the current cost to replace the personal belonging with a new item and reduce that amount by 10 percent for each year the individual owned the item. This amount generally represents the decrease in FMV of the item and is compared to the cost basis of the item. Any reimbursements are subtracted from the lesser of the cost basis, or the decrease in FMV, to arrive at the net casualty loss. Unlike the other safe harbor methods, taxpayers choosing this method must apply it to all personal belonging losses claimed under the federally declared disaster.
Cost Indexes Safe Harbor Method (Personal-use residential property only)
Specifically reserved for taxpayers who suffered a casualty loss due to Hurricanes Harvey, Irma or Maria, this method allows taxpayers to determine the decrease in FMV based on a structured cost index method. According to tables 1–7 below, this method covers circumstances ranging from damage to decking attached to the taxpayer’s personal residence to the total loss of the residence. For situations falling under tables 1, 2, 5 or 6, the total square footage of the residence is multiplied by the applicable cost index. For tables 3, 4 and 7, only the square footage of the affected area is multiplied by the cost index. If a taxpayer’s personal-use residential real property contains more than one personal residence, the same table must be applied to each personal residence.
Example: Taxpayer purchased a 2,000-square-foot personal residence in Florida for $500,000, and it was a total loss after Hurricane Irma. Insurance reimbursed $100,000. Taxpayer chose to use the Cost Index Safe Harbor Method. Using table 1, the taxpayer would compute the decrease in FMV as follows:
2,000 sq. ft. x $208/sq. ft. = $416,000
The lesser of the residence’s basis ($500,000) and the decrease in FMV ($416,000) is $416,000; therefore, the taxpayer would subtract the $100,000 insurance reimbursement from $416,000 for the individual’s casualty loss of $316,000.
For more examples, see pages 21–29 of Rev. Proc. 2018-09.
Table 1 – Total Loss
Table 2 – Near Total Loss
Table 3 – Interior Flooding Over 1 Foot
Table 4 – Structural Damage to a Personal Residence from Wind, Rain or Debris
Table 5 – Roof Covering Damage from Wind, Rain or Debris
Table 6 – Damage to a Detached Structure
Table 7 – Damage to Decking
For more information on how the revenue procedures affect you and your personal tax situation, contact Luke or your trusted BKD advisor.