Wildfires, Floods, Hurricanes: How the IRS Has Your Back
Disasters are all over the news these days. Severe calamities that cause widespread damage, such as large wildfires, floods, hurricanes, and earthquakes, ordinarily result in a disaster declaration by the U.S. president.
There’s nothing good about a disaster, but at least the tax law can help disaster victims in various ways. And recent changes in the law provide even more ways to get tax relief.
You’re probably aware that declared disaster victims can deduct the value of their uninsured losses from their tax returns, subject to limits. There are several other forms of tax relief for disaster victims, including those described below.
Postponement of tax deadlines. The government automatically extends tax deadlines for 60 days for those in federally declared disaster areas. But the IRS usually exercises its discretion to postpone such deadlines for up to one year. The IRS announces the extensions on its website.
Penalty-free withdrawals from retirement accounts. Taxpayers who suffer losses due to federally declared major disasters may withdraw up to $22,000 from their IRA, 401(k), or 403(b) account without penalty. And they can pay the regular income tax due on the withdrawals over three years.
Disaster relief payments are tax-free. Relief payments to disaster victims from federal, state, and local governments are tax-free. Disaster mitigation payments, which are made to lessen or avoid the effects of future disasters, are also tax-free. Payments that charitable organizations make to disaster victims are ordinarily tax-free gifts.
Qualified wildfire relief payments. Under new legislation passed in late 2024, most payments triggered from federally declared disasters caused by forest or range fires are tax-free. This relief applies to qualified wildfire relief payments received from January 1, 2020, through December 31, 2025.
Taxpayers who previously paid tax on wildfire receipts that are now tax-free may amend their tax returns for a refund, including from the years 2020 and 2021. The new law overrides the statute of limitations for these payments and allows amended returns until December 12, 2025.
Casualty gains can be tax-free or deferred. Disaster victims can end up owing income tax on casualty gains. These occur when the insurance received due to a disaster exceeds the adjusted basis of the property damaged or destroyed by the disaster or other casualty event. But there are ways to avoid owing tax on casualty gains, such as the following:
You can treat the damage or destruction caused by a disaster as an involuntary conversion and postpone reporting the gain if you spend the insurance recovery funds to repair or replace the property within two years—four years for your main home if it was in a federally declared disaster area. If you use all of the insurance proceeds you receive to purchase replacement property within two or four years, your casualty gain will not be taxed.
If the casualty completely destroyed your main home, you can treat the casualty gain as profit from the sale of your home. Then, if you qualify for the home sale exclusion, you can exclude from your income $250,000 of your gain if you are single or $500,000 if you are married and filing jointly. The destruction does not have to be from a federally declared disaster.
If you want to discuss any of these rules, please give us a call.