Disaster Victims who lost second
homes in wildfires of 2007: by Anna Maria Galdieri,
CPA
Following the aftermath of the 1991 firestorms in Oakland,
California, I wrote a number of columns for the Phoenix Journal and the Oakland
Montclarion. It appears that the need arises again to start that practice
again. In this column I am going to answer questions that I have been
asked by a number of disaster victims.
I lost my vacation home in the fires, and when I went to see
my tax preparer, I was told that I had to pay tax on the money I got from the
insurance company. Is this true?
No one who lost their second home in the wildfires who is rebuilding,
intends on rebuilding or has purchased a replacement residence will pay tax on
their insurance proceeds. Under the rules of IRS Code Section 1033(a) if
you receive one more dollar in insurance proceeds than your cost basis in your
second home, you can “DEFER” the gain realized by reinvesting in property that
is similar or related in service or use. In plain English this means that
if you lost your vacation home and rebuild or purchase another vacation or
second home, you won’t pay any tax on the insurance money you got. The
“price” you pay is that the basis in the replacement home is reduced by the
amount of the gain realized. For example, your cost basis in your home is
$150,000. You get $300,000 for your home. Your realized gain is
$150,000. You rebuild for $300,000. Your basis in the new home is
$300,00 minus the deferred gain of $150,000 or
$150,000.
You can go to the CAReHelp.org
website and review the Power Point presentation that includes the relevant
cites to the IRS Code Sections and Revenue Rulings that your tax preparer should
know about when working with you.
My tax preparer is telling me that I have until the end of
2008 to rebuild my vacation home destroyed in the wildfires? IS this
true?
No, this is not the case. Under the provisions of 1033, which
is a relief provision there to assist you in the rebuilding process, you have
two years from the end of the year in which you realize gain to rebuild, or
replace your second home. Gain is realized when you receive one more
dollar in proceeds than your cost basis in your home. If you cannot
rebuild within this time frame, there is also a provision that allows you to
request an extension of time from the IRS. I have done this for many
disaster victims who were unable to rebuild, or replace their property within
the time period.
Assume your cost basis in your vacation home is $150,000. In
December, 2007 you received $155,000 from your insurance company. Your
realized gain is $5,000. In 2008 you receive another $100,000 from the
insurance company. Since you realized gain in 2007, you have until
12/31/2009 to replace or rebuild your vacation home, and if you are unable to
meet this deadline, you should request an extension of time from the district
director starting in October of 2009.
I lost my second home in the wildfires. I heard that my
contents money is exempt from tax? Is this true?
Unfortunately, if you lost your second home in the Presidentially declared
disasters of Southern California, or if you lost your primary residence in the
Angora fires in South Lake Tahoe in 2007, the money you receive for your
personal property is not exempt from tax. Contents money is exempt only
for homeowners who lose their primary residence in a Presidentially declared
disaster. There is no good tax policy reason for this difference, and when
we tried to get our representatives to hear us, they told us that it would not
be politically feasible to enact a law that would treat all disaster victims the
same.
The problem that you as a homeowner face is determining whether you have a
gain or loss. And it is complicated by the fact that the measure of the
gain under Section 1033, the controlling section, is that you must use your
original cost of all the items you lost to determine if you have realized a
gain. On the other hand, you must use depreciated value if you are trying
to determine whether you suffered a loss. And neither of these values are
what the insurance company uses to determine if you have reached your policy
limits.
If you don’t realize a gain, the money doesn’t have to be reinvested in
contents. If you do realize a gain, under the strict rules of 1033(a) you
must reinvest in property that is similar or related in service or use.
There is no IRS guidance on this, and the only private letter ruling out there
is a ludicrous holding that art work done in an oil medium is not the same as
art work done in water color. I do know from Joe Calderaro of the IRS who
worked closely with me during the Oakland firestorm that you are not going to
have to replace a fork with a fork, and a sofa with a sofa. As long as you
spend the money on household contents, you’ll meet the requirement of this
section.
You may want to consult with your tax advisor to discuss the possibility of
using the common pool of funds theory that has been codified under Section 1033
(h) if you find that you’ll need to use your contents money to help you
rebuild. This theory came out of a 1950s court case where the court held
that the taxpayer met the requirements of 1033(a) since they had reinvested all
their proceeds, even though they spent tangible property money on real
property.
Anna Maria Galdieri, CPA
6517 Dana St
Oakland,CA 94609
Phone:
510-601-6691
Fax: 510-601-1342
amgaldieri@pacbell.net
---