Hurricane Sandy was a major blow for several homeowners and businesses. The losses are unprecendented for the region and will trigger an excessive number of insurance claims. It’s important to understand the tax ramifications, if any, for receiving an insurance settlement on a claim.
What happens if I have significant damage and it is not covered by Insurance?
Before we get to the insurance settlement, let’s suppose that some of the costs aren’t covered by insurance. What are the tax rules for deducting the costs? The IRS allows you to report personal casualty losses as an itemized deduction on your form 1040. Scenarios that might qualify would be if the fair value of your property was reduced due to a hurricane, tornado, flood, fire, earthquake, bomb, vandalism, or theft. Before you start to feel relieved, it’s important to note that there are two rules that generally apply to claiming losses as a deduction. 1) The deduction you can take must first be reduced by $100 and 2) The deduction must then be reduced by 10% of your adjusted gross income. This means that if your loss was $20,000 and your adjusted gross income is $150,000, you would be able to deduct $4,900 or ($20,000 – $100 – ($150,000*10% =$15,000)). Now for the good news, if your loss was due to a federal declared disaster, which is the case for states impacted by Hurricane Sandy, then you can take the deduction in the preceding tax year to get the savings sooner. For instance, let’s suppose you had severe flooding from Hurricane Sandy, you could amend your 2011 tax return to claim the deduction now rather than wait until filing your 2012 return which will be sometime by April 2013. Just keep in mind, that if you are using a tax preparer to file your amended return, it will likely cost a few hundred dollars, so depending on your situation, it may make more sense to wait.
What happens if I am partially covered by Insurance?
Any insurance proceeds received will reduce the amount you can claim as a personal casualty loss. For instance, if in the above example an insurance company paid you $5,000 for the $20,000 loss, a $15,000 loss would be subjected to the $100 and 10% of AGI rules. This would mean that you wouldn’t be able to deduct anything because 10% of your AGI of $150,000 is $15,000 which is equivalent to your loss.
What happens if the Insurance Proceeds are Greater than the Basis of the Property?
It’s possible for the insurance proceeds to be greater than the basis of the damaged property, in which case you would have what is called an involuntary gain. This gain is taxable on your return if you do not use the proceeds to purchase replacement property or do not elect to defer the gain.
What if the insurance proceeds cover the cost of the damage and nothing more?
In this case, the insurance settlement will not be reported as taxable income and you won’t claim a tax deduction since the insurance company covered the costs.
More Questions? Browse answers or ask hurricane insurance tax questions online.
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