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Preparing Yourself for the Financial Effects of Severe Weather

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Did you know there have been 47 disaster declarations already this year? With hurricane season starting and a devastating wildfire season already underway, now is the time to prepare yourself in case you are impacted by a disaster or other casualty loss. Unknown to many taxpayers, are the very pro-taxpayer rules for your tax return if you suffer from a casualty, theft, or disaster loss and preparing beforehand can help speed up the process if you are impacted by an event. While this is a best practice, let's be real -- not many people prepare for taxes during the tax year, let alone for tax consequences of a disaster event. Having said that--and while advanced preparation is the best, there are also things you can do after an event to still take advantage of the beneficial tax rules

First, let's look at what you can do before a casualty or disaster strikes and secondly what you need to do if you are involved in one.

What is a casualty or disaster for tax return purposes and what should you do to prepare yourself before a casualty or disaster strikes? So glad you asked. A casualty is the damage, destruction or loss of property resulting from an identifiable event that is sudden, unexpected or unusual. It does not include damage from routine wear and tear (such as termite infestation or gradual mold damage). A disaster is a large scale casualty event that has been designated a disaster area by the president. The IRS allows you to claim a casualty, or theft, loss on your tax return. That is correct -- a tax deduction on your tax return for damage or loss you suffer from a catastrophic event.

Of course, there are rules and limitations. You must itemize deductions to claim the loss, you must also deduct $100 from each separate casualty event and deduct ten percent of your adjusted gross income from your total losses. Sounds a bit complicated and it is, but the tax benefits may be worth it. The remaining loss after those computations and limits is then allowed as an itemized deduction reducing your taxable income and therefore your taxes. Most losses are deducted on your tax return for the year the loss occurred, but there are special rules when you suffer a loss due to a federally declared disaster, such as Hurricane Sandy in 2012. What can you do to help minimize the confusion that comes with claiming a casualty loss before one occurs? Here are some timely tips to help you prepare:

  • Take a Home Inventory. Walk through each room in the home and record all items in writing, noting a description, cost and fair market value. The Jackson Hewitt Household Inventory List is a helpful guide. If you are not the writing type, consider a short home video, by room and area detailing what you have and particular items of value and risk like jewelry or other highly at risk property.
  • Understand What is Not Covered. Casualty-related expenses that cannot be deducted as losses include the cost of repairing damaged property, restoring landscaping to its original condition or cleaning up after a casualty.
  • Know How to Document Losses. In addition to proving the amount of loss, you are required to prove to the IRS that you owned the property or are responsible for any damage to the property, and that there was an event that directly caused the loss. As a general rule, keep any documentation that validates property ownership, the fair market value of the property, and the cost of any improvements to the property.
  • Keep Important Documentation in a Safe Place. Make copies of all of your important documents such as your insurance policies, birth certificates, and marriage licenses and don't forget to include copies of your home inventory. Store the copies in a secure electronic document storage program or cloud back up, or on a portable drive or CD and in an off-site location like a safe deposit box or with a family member. Finally, secure all your original documents in a waterproof container in either a small safe or other location that is easy to access should you need to evacuate.

But what do you do after the casualty or disaster?

  • Document your loss. Take photographs or videos of the damage to your property, as well as any repairs. It's also important to keep any and all receipts for repairs or clean-up work. While these are not deductible losses, repairs or clean-up expenses may help establish a decline in the fair market value of your property as long as the expenses are incurred to restore the property to its original condition. If the disaster that affected you is not widely known, be sure to save any police reports or newspaper articles to document the event.
  • Know your deadlines. The IRS may postpone certain tax deadlines for taxpayers who are affected by a federally declared disaster. These extensions can push standard deadlines as far back as one year and may include filing income, excise and employment tax returns, paying taxes associated with those returns, and making contributions to a traditional IRA or Roth IRA. The IRS typically publishes announcements about postponed tax deadlines on the IRS website disaster page.
  • File a timely insurance claim. If your property is covered by insurance, you should file a timely insurance claim for reimbursement of the loss. Not filing an insurance claim may limit your eligible casualty or theft loss to the amount that is normally not covered by your insurance, such as your insurance deductible amount.
  • Be aware of federally declared disasters. Additional tax relief may be available if an area is declared a federal disaster area. A list of current disasters is available on the Federal Emergency Management Agency (FEMA) website. If you have been affected by a federally declared disaster, you must choose how you will claim the loss -- either as part of your itemized deductions for the year in which it occurred or by amending your prior-year tax return and claiming your deductions in the previous tax year. If you have a loss in a federally declared disaster area since January 1, 2013, you may claim the loss on your 2012 tax return or wait until you file your 2013 tax return next year. If you have already filed your 2012 tax return, you may amend the return to claim the loss now.

Unfortunately, natural disasters, and losses from them, occur each year and cost Americans billions of dollars. The income tax rules may provide a small silver lining if the right circumstances apply. There are potential tax deductions, filing delays, extensions of time and other provisions that may help reduce your taxes, get money back, or get money back faster if you are severely impacted. However, as with all best practices to make the most of your tax situation, you need to plan ahead, understand the rules or get help in doing so, and document all of the facts and circumstances as much as you can and as detailed as you can. First and foremost, be safe and protect yourself and your family, secondly if you have a catastrophic loss start looking at the income tax return implications and make the most of the rules to get more money back. The income tax return benefits of the disaster and casualty loss rules are there for you. These tax rules may not make you whole again and certainly cannot replace precious sentimental items or life lost, but they can lighten your taxes and may even put more money in your pocket -- when you need it most. Prepare ahead if you can, and even if not, understand the rules after the fact or find professional help that does and get all of the tax benefits you deserve.