Not too long ago, I was working in my home office when I was sure that the washing machine upstairs was completely unbalanced. As I started up the stairs I realized that the washing machine was off and I was going through an earthquake. I spent a few years in Japan, so this wasn’t my first rodeo, but I do have to tell you the earthquake that hit Northern Virginia last summer certainly got my attention.
We had a few things fall off shelves, but as I walked around the house I was relieved to see that there was no major damage (although it does appear now that we have sustained some damage to our chimney). What if I had had major damage? What would the insurance and tax implications be?
Insurance. Generally speaking, most insurance policies do not cover damage caused by “earth movement” otherwise known as earthquakes. Most also do not cover damage caused by flood (other than caused by broken pipes or sewage issues). To have coverage against these perils you need to purchase a separate policy or rider. In some cases, such as if you live in the 100 year flood plane, you may have to purchase special insurance to qualify for a mortgage. Every time you PCS you should take a look at your insurance policy, weigh it against the probability of a particular peril and determine if you need an additional policy or rider. In my case, I didn’t purchase an “earthquake rider”, so any damage caused by the earthquake is mine to pay. But, the IRS may help me out a little.
Tax Implications. The tax code does allow for certain deductions if you sustain losses and the losses were not covered by insurance. However, you must itemize to be able to deduct casualty losses. There are two different scenarios depending on whether the loss occurred in a federally declared disaster zone or not.
- Outside a Federally Declared Disaster Area.
- The deductible amount of the loss is calculated as follows
- Subtract $100 from each deductible loss (think of this as event. If you have a loss from an earthquake and then a loss from a flood you would subtract $100 from each event)
- Reduce the total loss by 10% of Adjusted Gross Income (AGI).
- The remaining loss is deductible if you itemize deductions.
- For example if a taxpayer has a loss of $10,100 dollars and an AGI of $50,000 the loss would be calculated as follows:
- $10,100 loss is reduced by $100 for an initial loss of $10,000
- $10,000 is further reduced by $5,000 (10% of AGI) for a final deductible loss of $5,000
- The loss is determined as follows
- Calculate the basis of the item (most likely the price paid for personal property)
- Calculate the reduction in Fair Market Value of the item
- From the smallest of 1 or 2 above subtract any reimbursement (such as insurance).
- The remaining value is your loss, used above to calculate the deductible amount
- For example.
- You paid $1,000 for a new table. This is the table’s basis
- During an earthquake the table loses a leg and is now worth $500 so the FMV was reduced by $500
- You received no reimbursements, so the loss used to calculate the deductible loss is $500
- If the loss occurs in a Federally Declared Disaster Area the situation changes as follows:
- The primary changes in deductions are in when you may claim them and when you can delay filing
- You have the choice to deduct your loss on the previous year’s return. If you have not yet filed your taxes you would claim the loss when you file your return. If you have already filed, you can file an amended return (IRS Form 1040X)
- The IRS MAY postpone for up to one year the filing deadline for individuals in certain Federally Declared Disaster Areas
- Also, certain relief payments may not be subject to tax. See IRS Pub 547 for details
The moral of the story for this post is: First, make sure you know which perils you are insured against. Second, if you have a loss that isn’t covered by your insurance, you might be able to get Uncle Sam to pick up part of the bill.
Curt Sheldon, EA is a Fee-Only Financial Planner and Enrolled Agent based in Northern Virginia. He can be contacted at (703)542-4000, (800)928-1820 or Curt@CLSheldon.com
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The information contained in this blog is for general financial education and should not be construed as individual financial advice. Please consult your own financial, tax or legal advisor prior to applying any principles discussed here to your own financial situation.