Highlights
- Between wildfires such as the ones in Southern California earlier this year and hurricanes and other major storms experienced by other parts of the country annually, there is no shortage of natural disasters affecting people and property.
- When such disasters strike, the resulting losses often trigger a variety of federal and state tax consequences.
- This Holland & Knight alert examines many of the issues taxpayers may face when dealing with disaster aftermath.
Whatever one may believe about climate change, there is no denying that there has been a series of natural disasters over the past decade. Most recent was the devastation of the January 2025 fires in Southern California. Others readily come to mind – the spate of large hurricanes, many of which have caused significant damages not only in the Gulf states and Caribbean, but farther north as well. Tornadoes routinely rock the Midwest. California's Camp Fire in Butte County in 2018 may have caused more deaths than even the recent fires, and California may be overdue for the earthquake known as "the Big One" (7.8 or greater on the Richter scale).
Losses resulting from disasters may trigger a variety of federal and state tax consequences. These can include:
- the treatment of losses
- the effect of insurance recoveries and gains
- rules relating to involuntary conversions
- the treatment of qualified disaster relief payments
- extended due dates
- the impact on gift and estate planning due to the effects of disasters on asset values
This Holland & Knight alert will highlight some of these issues – it would take a treatise to cover them fully.
The Treatment of Losses
Who Is Affected? Those affected by federally declared disaster areas include individuals, businesses entities, shareholders in S corporations and tax preparers whose principal place of business is located in federally declared disaster areas. Also included are those whose tax records are located in a disaster area, all relief workers, and visitors who were killed or injured as a result of the disaster.
The Amount of the Loss. Most people have some sense of what their property is worth. When that property is damaged or destroyed, that's the value that's thought of as lost.
But that isn't the loss for tax purposes. Your loss is the decrease in value of your property, but the loss may not exceed your "adjusted basis." Adjusted basis, in most cases, means the original cost to acquire the property, increased by the cost of improvements and decreased by any depreciation deduction that was allowed or allowable to you. If the property was acquired by gift, your original basis will be the lower of the donor's adjusted basis and fair market value of the property at the time of the gift. If the property was acquired by inheritance or otherwise by reason of the death of the donor, the original basis will be the fair market value of the property at the date of death (or sometimes six months later), whether or not that value is more or less than the decedent's cost.
In other words, if your property was purchased for $100,000, you installed landscaping of $10,000 and your property was worth $150,000 on the date it was destroyed, your uninsured loss for tax purposes cannot exceed $110,000.
Federally declared disaster areas are determined by the Federal Emergency Management Agency (FEMA), which provides a searchable website for finding such locations. The FEMA disaster number for the Los Angeles wildfires is 4856-DR, and it should be written at the top of all filings. To obtain copies of your tax returns, file Form 4506, Request for Copy of Tax Return. The normal $50 fee will be waived on forms that have "4856-DR" written across the top.
Personal Casualty Losses. Though losses from the sale or exchange of personal use property generally are not deductible, a loss of such property from certain casualty events generally is deductible, subject to limitations. A qualifying casualty event includes wildfires, storms and other events where the destruction, damage or loss of property occurred in an event that was sudden or unexpected. It does not include a gradual, intentional or day-to-day occurrence. If deductible, casualty losses are deductible in the tax year the qualifying casualty event occurred, subject to a special rule described below for losses incurred in federally declared disasters. IRS Publication 584, Casualty, Disaster, and Theft Loss Workbook, provides additional information on valuing a deduction.
Theft Losses. A loss on personal property due to theft is deductible only if it occurred in a federally declared disaster area. Some examples of theft losses are blackmail, burglary, embezzlement, extortion and kidnapping for ransom. The act has to be illegal under state or federal law. If you have more than one personal casualty or theft loss in one year, losses must be offset by gains, which can result from insurance receipts.
Timing: When to Claim Loss
Normally, a loss of any kind, if deductible, must be claimed for the year in which the loss occurred. However, where the loss resulted from a federally declared disaster, you may instead elect to deduct the losses in the tax year prior to the loss. To claim a loss incurred in 2025 in a prior tax year, you must file an original or amended tax return and make the election on Form 4684. For those affected by the Los Angeles fires, the 2024 tax return for persons covered by the IRS announcement mentioned below (or if an automatic extension is applied for on Form 4848) will be due Oct. 15, 2025 (see Extended Due Dates below). You have to prove the loss and show that you were the owner of the property, provide the type of casualty (e.g., fire), show that the loss was a direct result of the casualty, and if and to what extent you were reimbursed for the loss.
If a loss occurs in one year, the loss may be deducted in a subsequent year when the actual amount of the loss is known. Reimbursements that reduce your casualty loss are limited to replacement of lost or destroyed property. The repairs to the property must be made in order to claim the loss. Estimated cost of repairs cannot be used.
Insurance and Reimbursements
What about insurance? Most people would not consider the proceeds of insurance, even replacement cost insurance, as fully compensating them for losses incurred in a disaster. But this entirely legitimate emotional response is not necessarily reflected in the tax treatment. First, a tax loss is reduced by the amount of any insurance recovery. Then, to add fuel to the fire, so to speak, if the insurance recovery exceeds the adjusted basis of the property, the excess may be taxable, as discussed further below.
If you deduct a loss on a tax return and thereby receive a tax benefit, then a reimbursement in a subsequent year does not require your tax return to be amended. Instead, you report the reimbursement as income in the year it is received. The actual amount of the disaster loss is the amount of the loss less reimbursements. Relief payments and reimbursements for food, living expenses, medical supplies or other forms of assistance are not taxable income.
Involuntary Conversion
In the case of the "involuntary conversion" of your property, you may be able to avoid immediate recognition of gain on the excess of insurance proceeds and other compensation over your adjusted basis. Involuntary conversion is defined as the destruction, condemnation, casualty or loss of your property, and the concept comes into play if you receive other property or money to replace it.
As explained above, any gain or loss is reported on your tax return in the year you realize it. However, you do not report gain if you receive or acquire property that is similar to the property you lost. The basis of the replacement property is the same as the basis in the original property. For example, if you use insurance proceeds to rebuild a home destroyed by fire or acquire a different home, you can avoid recognition of gain. Your replacement property will have the same basis as the property you lost, subject to adjustments, which will depend on whether you received replacement property or, as would more commonly be the case, money to reimburse you for your property loss that you reinvested.
A special rule applies where a principal residence is lost as a result of a federally declared disaster. In such a case, no gain is recognized by reason of the receipt of any insurance proceeds for personal property that was part of the contents of the residence and not "scheduled property" for purposes of such insurance. For nonscheduled property, the loss is considered to result from the loss of a single item of property – as a result, there does not have to be matching of the property lost against the replacement property.
Treatment of Qualified Disaster Relief Payments
Qualified disaster relief payments are paid by federal, state or local governments to individuals (generally, businesses don't qualify) and must be made from a governmental fund. Payments are for reasonable and necessary expenses that include 1) personal and family expenses, such as food and medical supplies, or living expenses, 2) funeral and reburial expenses related to a federally declared disaster area, 3) repair of a personal residence that you own or rent, and 4) repair or replacement of the contents of a personal residence that you own or rent. These payments are not subject to income tax, self-employment tax or employment taxes of a self-employed individual, unless the expenses were also covered by insurance or other types of reimbursements.
Property Tax
Each state has its own rules for dealing with property taxes relating to property lost or damaged by fire or in some other form of disaster.
In the case of the Los Angeles fires, real property that is damaged or destroyed may be reassessed by the Los Angeles County Assessor's Office. Form RP-87, application for Decline-in-Value, is generally filed beginning in July (in 2024, the dates were July 2-Nov. 30); as of the date of this alert, the assessor's website does not list the exact dates for 2025, and Form RP-87 for 2025 is not yet available. You must show that on Jan. 1, 2026, the market value of your property is less than the current assessed value.
Extended Due Dates
As explained in Holland & Knight's previous alert, the IRS and the California Franchise Tax Board have extended deadlines for all tax related filings that have either an original or extended due date on or after Jan. 7, 2025, and before Oct. 15, 2025, have been extended to Oct. 15, 2025. These filings include:
- individual income tax returns
- estimated tax payments due April 15, June 15 and Sept. 15, 2025
- corporate, partnership, S corporation, fiduciary for estates and trusts, estate tax, gift and generation-skipping transfer tax returns
- annual information returns for tax-exempt organizations, employment, and certain excise tax returns and foreign bank and financial accounts (FBARs)
Estimated tax payments due after Oct. 15, 2025, have not been extended.
Extensions are automatic. You do not have to file for them. However, if you are not a resident of Los Angeles County but have been affected by the disaster (such as a person whose records are located in Los Angeles County or a relief worker wherever residing), you must contact the IRS to request relief.
Some Other Considerations
Charitable Donations. Donations of property to charities (501(c)(3) organizations) are deductible on your income tax return. The value of the property is its fair market value. Be sure to get a receipt from the charity. Donations to individuals and of your time are not deductible. Your out-of-pocket expenses are deductible, along with your mileage at the rate of 14 cents per mile for 2025 and parking and tolls. Keep records of your mileage, including date, location and miles driven. Lodging and meals are deductible only if you are away from home overnight. Clothing worn while volunteering is not deductible if it can be worn when not volunteering.
Distributions from Retirement Accounts. A retirement plan may allow hardship distributions due to immediate and heavy financial need. The amount of the distribution is limited to the amount actually needed, and funds can't be obtained somewhere else. An employee is automatically considered to have an immediate and heavy financial need if the expenses are related to the repair of the employee's principal residence. Hardship distributions are subject to income taxes and can't be repaid.
Estate and Gift Tax Considerations
When a home or building is destroyed or damaged, the result will plainly be a change of value for purposes of the gift and estate taxes. In a simple case, where a home is damaged or destroyed by fire, the building's value may decline to as low as zero, but the value of the land may be largely unaffected beyond the cleanup costs. But in a widespread disaster such as the Los Angeles fires, that may not be the case. The value of land itself may be significantly diminished in an area where fire has destroyed a large number of homes and, as in Pacific Palisades, the commercial area that formed part of the affected community. The diminution may result from uncertainties about the building process, including widespread environmental problems and issues affecting timing and difficulties of rebuilding both the damaged property and the rest of the neighborhood. Any such diminution in value may not be permanent; if it is desired to take make a gift based on a lower value, it would likely be preferable to make the gift before the various uncertainties begin to be resolved.
Declines in value may provide an opportunity to make a gift at a significantly lower value than the pre-disaster value. However, any planning must take into account the basis rules that apply to gifts. The basis of property acquired by gift is generally the lower of the adjusted basis in the hands of the donor and its fair market value. Complication can also result from the need to allocate the original basis between the land and the property
For example, suppose a home was acquired for $700,000, of which $250,000 was attributable to the land and $450,000 to the value of the house. Suppose further that the home had a pre-fire value of $1 million, of which $400,000 was attributable to the land and $600,000 to the value of the house. As a result of the fire, the building is worthless and the land is now worth $150,000, because no one wants to take a chance on when and how rebuilding will be possible. If the land were given by the owner to his or her child, the child would have a basis of $150,000 in the land. Further, if the owner received insurance proceeds of $600,000 for the house, the owner would pay tax on $150,000 ($600,000 minus $450,000). That gain would not be deferred unless the owner rebuilt the house – giving the insurance proceeds to the child would not change this result.
The result described in the example could readily change depending on the relevant numbers, and it would be important to involve an appraiser or other qualified real estate professional in undertaking an analysis.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
