If you own a business and it suffered from damage due to a flood, fire, or an accident, it is wise to visit with a tax attorney about property damage and taxes and the possible correlation between the two. Depending on the value of an item and the insurance coverage for it, it may be possible for a business to experience a gain for a casualty loss. This gain is then taxable, but by enlisting the help of a knowledgeable attorney who has an intimate understanding of business and tax law, there may be opportunities to minimize that taxable income.
Claiming Business Property Damage
One of the first steps in claiming property damage is to file the IRS Form 4684 regarding casualties and thefts. In terms of federal income tax purposes, casualties are typically defined as an unexpected or sudden damage or loss of property. This generally covers natural disasters such as hurricanes, floods, tornadoes and earthquakes, but may also cover other specific scenarios as well.
As for determining what business property is worth, it comes down to estimating its adjusted tax basis immediately before the loss, minus its salvage value. In other words, calculate what the cost of acquiring and improving the item was and then subtract depreciation deductions. Then subtract the amount the property is worth post-casualty.
If casualties caused business property to be destroyed, the business may want to see about claiming a deduction for it. This, however, requires the claiming party to prove:
- Ownership of the property
- Amount of basis in the property
- Pre-casualty value of the property
- Reduction of value caused by casualty
- Inability of reimbursement to cover costs
These safeguards have been put in place to better prevent abuse of the system.
Deducting Casualty Losses
According to the Internal Revenue Service, casualty losses may be deductible, but only in the year of the event that caused the loss. It is worth noting that something is not considered a loss if it could potentially be recovered through a reimbursement claim.
If a casualty loss is the result of a federally declared disaster, this situation can come with more specific guidelines about when to deduct that property on your taxes.
Property Damage and Taxes: Losses Could Result in Taxable Gains
What some business owners may not realize is that with insurance reimbursements, it could be possible to receive more than the adjusted basis of damaged property, and that can result in a taxable gain.
However, some gains are eligible to be deferred only if certain replacement property is purchased. For this to work, replacement property must generally be purchased within two years of the tax year that the gain occurred.
In a situation where a loss deduction exceeds your income, it may result in an NOL, or net operating loss, for that year. Essentially NOLs may help minimize taxes for a previous tax year which could in turn yield a tax refund. In order for a business to see if this is a scenario that is applicable to them, it is wise to first seek the counsel of an attorney that has a business and tax background. They can assist with determining eligibility.
Minimizing Taxable Income from Casualty Loss Insurance Recoveries
When it comes to the loss of business property, considering the fact that a business might get a taxable gain back can be the furthest thing from an owner’s mind. Still, if not strategic about handling that gain, it may end up being taxable instead, which can be like adding insult to injury.
A reputable tax attorney should be familiar with ways to potentially minimize or eliminate taxable gains as the result of casualty losses. One of the most frequently utilized options has to do with reinvesting. Federal tax rules may allow businesses with a taxable gain to minimize or reduce it by reinvesting the insurance money in what is commonly defined as “similar use” property.
Consider the two following scenarios:
- A company purchases a vehicle for a certain price. Some years later said vehicle is totaled and is assigned a depreciated tax basis. If the insurance company reimburses the company at a rate higher than the depreciated tax basis, that amount is considered taxable.
- In the same situation, if the company decides to reinvest that taxable amount into a replacement vehicle, it is not necessarily required to report the taxable gain as long as certain conditions are met.
Most businesses would prefer to be in the second situation so that they are able to replace what they lost and are not being taxed for a gain, but for this to work it can take a skilled tax attorney to ensure that it is marked correctly on the business’ tax return. The process can be quite complex with a number of guidelines and specifications that must be met.
For example, in general, the replacement property for reinvestments is two years. It may not be valid after the fact, although there may be some limited exceptions offered by the Internal Revenue Service in certain situations.
What to Look for in a Tax Attorney for Your Business
Tax attorneys should have a background in working with businesses on matters like the above, but it is equally important to make sure that the attorney you hire meets several qualifications, such as:
- Experience. It is critical to hire an attorney who has specific knowledge and understanding of business tax matters. Verify how many business tax cases they have taken, what they involved, and the outcomes of each.
- Knowledge. In addition to being certified to practice law in Texas, an attorney should have extensive knowledge of federal and state tax laws. It is also important that legal counsel stay up to date on these mandates as they can change periodically and may significantly impact a business’ bottom line.
- Representation. In the event that a dispute arises, it is necessary that the attorney hired can represent your business in a court of law.
Don’t let ill-managed property damage and taxes unnecessarily cost your business. Enlist the help of a trusted tax attorney today and determine your options on properly handling a loss.
- What is a Business Lawyer? - November 27, 2023
- Episode 309: Offers in Compromise: Options, Benefits and the Process - November 17, 2023
- Episode 308: Wills, Powers of Attorney, Directives and Guardianship - November 2, 2023