Victims of the recent hurricanes are likely still salvaging their belongings and sending out insurance claims. However, many affected clients may benefit by knowing what tax relief could be available to them.

Here a five tax strategies to keep in mind when dealing with clients affected by natural disasters.

Destroyed homes and vehicles sit in floodwaters after Hurricane Maria in this aerial photograph taken above Hamacao, Puerto Rico, on Monday, Sept. 25, 2017.
Destroyed homes and vehicles sit in floodwaters after Hurricane Maria in this aerial photograph taken above Hamacao, Puerto Rico, on Monday, Sept. 25, 2017. Bloomberg News

DEDUCT LOSSES IN PRECEDING YEAR
A taxpayer who suffers a disaster loss can take the deduction in the tax year in which the disaster occurs, or can elect to deduct the loss in the immediately preceding tax year.

Claiming the disaster loss for the year before saves taxes immediately, without having to wait until next year. In some cases, the deduction may result in a net operating loss, which will bring a refund by a carryback to an earlier year.

On the other hand, deducting the loss in the year the loss actually occurred may result in bigger tax savings if the taxpayer is in a higher bracket that year.

HOW TO CLAIM DISASTER LOSSES
Clients, whose residence is located in a federal disaster area, may deduct any loss attributable to the disaster. However, these three requirements must be met:

  1. The taxpayer is ordered by the state or local government, in which the residence is located, to demolish or relocate the residence.
  2. The order is made no later than the 120th day after the area was deemed a disaster area.
  3. The residence was rendered unsafe for use as a residence because of the disaster.

REDUCED HOME SALE EXCLUSION
Clients can exclude any money earned from the sale of their damaged home. In fact, up to $250,000 of gain ($500,000 for certain joint filers) may be eligible.

However, there are strings attached. The exclusion will not apply if, during the two-year period ending on the sale date, the exclusion applied to another home. Secondly, the property must have been claimed as a primary residence for at least two of the five years prior to the sale.

If clients are not eligible for full-home sale exclusion, there still may be tax relief available. A reduced home sale exclusion could exclude a portion of the money from the sale of a damaged home, even if clients do not meet the two criteria mentioned above. Instead, they will have to prove that a change of employment, health reasons or unforeseen circumstances (like a natural disaster) was the reason they did not meet those requirements.

VOLUNTARY SALE OF DESTROYED HOMES
An event such as a storm, flood or hurricane may destroy only part of a client’s property. Or, authorities may only condemn part of a larger unit.

In this case, a voluntary sale of the property, if forced on the client will be treated as an involuntary conversion for tax purposes. In general, a client can claim damaged property as an involuntary conversion only if a two-pronged test is satisfied:

  1. The involuntarily converted property reasonably can't be adequately replaced.
  2. There must be a substantial economic relationship between the condemned property and the property sold so that together they constitute one economic unit.

To demonstrate the relationship between the damaged and undamaged properties, clients will have to prove that the property sold could not practically have been used without replacement of the converted property.

DEFFERING STATE RELIEF FOR BUSINESSES
A state may have a program to reimburse uncompensated business losses for disaster-related damage.

Eligible businesses may elect to defer the gain realized from receipt of the grant if the money is used in the timely purchase of new equipment or property that replaces the damaged ones.

Robert Trinz

Robert Trinz

Robert Trinz is a senior analyst with Thomson Reuters Checkpoint within the Thomson Reuters Tax & Accounting Business.
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