Natural disasters and other unforeseen circumstances like the California wildfires changes rules of the taxation for those who are badly hit or those who lose property. The law can lessen the worry over money and despair.

The changes to the tax rules in recent years give people more time to rebuild or purchase a new home and postpone dealing with tax issues. Insured disaster victims can now use insurance money more freely to rebuild without triggering taxes.

INSURED DISASTER VICTIMS:

INVOLUNTARY CONVERSION. It is used when you have a gain from insurance that you don't expect to report as income because you're going to use the cash you received to replace the property.

An involuntary conversion gives even more leeway if the disaster is declared federally. In that case, the homeowner gets four years to reinvest certain insurance proceeds to replace the home and its contents if he has realized a gain. For example, if the cost basis of the house is $150,000 and the homeowner gets a partial insurance payment of $150,001 in June 2008, he has until Dec. 31, 2012, to reinvest and report the gain. If it is too hard to meet the four-year deadline, one can apply for a year-by-year extension to reinvest.

Homeowners who lose their vacation homes have two years and owners of real property used in their trade or business or held for investment have three years.

PROCEEDS. In claims, the measure of the loss is not the replacement cost. It is based on the fair market value. Insured disaster victims experience a loss if their insurer won’t settle with the replacement cost of their real and personal property.

TAX EXEMPTION. A disaster victim who lose his/her principal residence located in a declared disaster area can apply the provisions in Sec. 121 exclusion where gain(s) realized or the money they received are tax exempt.

VALUATION. Since the exclusion wipes out the gain, when disaster victims rebuild or purchase a replacement home, the value of the taxable property is equal to their replacement cost. If disaster victims sell their replacement home within two years of purchasing or rebuilding it, their gain is only the appreciation that's occurred since they replaced their home.

If the disaster victims who lived in their homes less than the requisite two years, they can avail of a partial exclusion only.

REINVESTING PROCEEDS. Insured disaster victims who lose tangible personal property used in their trade or business or held for investment can reinvest their proceeds in any tangible personal property. So, someone who lost a flower shop, for example, can spend their insurance proceeds to start another business like an encoding or contracting business.

VACATION HOMES. Insured disaster victims who lose their vacation homes do not have the same benefits as disaster victims who lose their principal residences. They must reinvest their real and personal property dollars in a home and contents, or pay tax on the gain.

TRADE/BUSINESS/INVESTMENT PROPERTY. Insured disaster victims who lose real property held for use in their trade or business or for investment are held to a stricter standard for reinvestment.

Under Sec. 1033(g), a property owner who loses rental property can reinvest in a building that is like-kind, which is a broader definition than the functionally similar or related in service or use criterion of Sec. 1033(a).

REINVESTMENT PERIOD. Homeowners who lose their principal residence and realize a gain in excess of their Sec. 121 exclusion have four years to complete the reinvestment.

Homeowners who lose their vacation homes have two years and owners of real property used in their trade or business or held for investment have three years. I'm working with the IRS to obtain a consistent reinvestment period for all Southern California wildfire victims.

EXTENSION REQUESTS. Disaster victims who cannot reinvest within the requisite time frame can request an extension from the IRS.

UNINSURED PROPERTIES.

Uninsured disaster victims can use the Federal Emergency Management Agency appraisal of their loss to document their tax loss, a code section that was enacted after the Northridge earthquakes of 1994 [Sec. 165(i)(4)]. No loss can be taken until reimbursement claims have been settled.