Los Angeles Earthquake: Tax Provisions May Alleviate Financial Burden
Date: January 1994

The devastation caused by the recent Los Angeles earthquake cannot be measured only in monetary terms. Provisions in the tax code regarding casualty losses may, however, help alleviate the financial burden of significant property losses. Because President Clinton signed a federal declaration of disaster for Southern California, such losses may even be deducted on your 1993 tax return.

In the case of business and profit-oriented property, the tax law allows a deduction for loss not compensated by insurance or otherwise (subject to the limitation on losses from passive activities, etc.). As a general rule, a tax deduction is not permitted to individual taxpayers for losses to personal-use property, such as a residence. Special relief is available, however, for losses arising from a "casualty," such as a fire or earthquake. In such event, losses to private automobiles, home furnishings and other personal items may be deductible.

In the case of personal casualty losses, the deduction is limited by rules allowing losses only to the extent they exceed 10% of the taxpayer's adjusted gross income ("AGI") plus $100. AGI is basically gross income minus certain deductions. For example, assume a taxpayer has damage to his personal residence in the amount of $20,000, and the taxpayer's AGI for the year is $100,000. The casualty loss deduction is calculated as follows: $20,000 casualty loss minus $10,100 [$10,000 (10% of $100,000 AGI) plus $100] = $9,900.

I.     Substantiation of Casualty Loss

To substantiate a casualty loss the taxpayer must establish:

• The nature of the casualty and when it occurred,

• That the loss was the direct result of the casualty,

• That he was the owner of the property or was contractually liable to the owner,

• The cost or other adjusted tax basis of the property, evidenced by purchase contract, checks, receipts, etc.,

• The depreciation allowed or allowable, if any,

• The value before and after the casualty,

• The amount of insurance or other compensation received or recoverable, including the value of repairs, restoration and cleanup provided by relief agencies, and

• The absence of a claim for reimbursement for which there is a reasonable prospect of recovery.

II.     Amount of Loss

The loss is computed as the amount of decline in value, limited to the adjusted tax basis (or cost) of the property.

Reliable appraisals of the property's value immediately before and after the casualty are generally regarded as the best evidence to measure the amount of loss sustained. Treasury regulations require the appraisal to recognize the effects of any general market decline unrelated to the casualty.

Where property is partially destroyed, the cost of restoring it to its original condition may be regarded as acceptable evidence of its decline in value. Furthermore, expenses to remove debris and the cost of required cleanup have been held to constitute part of the deductible casualty loss. On the other hand, expenses for temporary accommodations for the period during which the taxpayer's home is without heat or light or is unsafe constitute personal expenses and may not be deducted as part of the casualty loss.

III.     Timing of Deduction

To accelerate the economic recovery in disaster areas, taxpayers may elect to deduct casualty losses either in the year the loss occurs or in the immediately preceding taxable year. Victims of the earthquake can therefore use the deduction on their 1993 or 1994 tax returns, whichever is more beneficial.

IV.     Business Property Losses

Owners of business or investment property may also qualify for casualty loss deductions. As with personal losses, the deductions can be taken on their 1993 or 1994 returns. Business or investment property losses are not reduced by 10% of AGI.

If you would like further information regarding the applicability of these provisions to your particular situation, please call our Tax Department, at (310) 858-7700.

Our Tax Department handles a wide range of federal, state and international tax matters involving tax planning for high net worth individuals, partnerships and corporations with particular emphasis on the entertainment industry. We have extensive experience in structuring real estate transactions, motion picture financings, partnerships and syndications, structuring the purchase, sale and reorganization of companies, and executive compensation arrangements.

Rosenfeld, Meyer & Susman was founded in 1957. The firm's areas of expertise include: Tax, Litigation, Corporate, Entertainment, Estate Planning, Trusts and Probate, Labor and Employment Law, Real Estate, Family Law, Insurance Coverage and Defense, Real Estate and Employee Benefits Law.

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