Tips for Disaster Survivors

CARe would hate to see your hard earned insurance settlement funds disappear in the current banking crisis.

  1. Have the mortgage company put any insurance settlement funds in a “trust” account related to your mortgage to best protect the entire amount of your recovery check.  The insurance recovery that the mortgage company holds should not be held in any “general” account or commingled with any other bank funds.  It may take talking to an upper-level bank official.
  2. Funds held in any bank should be limited to $100,000 per account to receive FDIC protection.  An account can have up to $200,000 but it needs two specific individuals.  Check with your bank.

I found this great paper written by Marshall & Swift/Boeckh (self described as providing "vital property information and services determine the costs to replace or repair residential and commercial buildings") about why reconstruction usually costs more than new construction. (Adobe Acrobat required.)
Here is another description I've found quite helpful.

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 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
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