Casualty Loss

Casualty Loss Can Generate Massive Taxwill take 12-18 months due to the labor
Deductionsconstraints and 5) the owner has casualty
A casualty loss may occur as a result of a flood,insurance to rebuild but did not have rent loss
hurricane, tornado, mudslide or other naturalbusiness interruption insurance.
disaster. The intuitive thought pattern is: "MyIt is clear the market value after the casualty is
apartment complex worth $5,000,000 sufferedless than the market value before the casualty
major damage totaling $1,500,000 for repairs andless construction costs. Other factors to consider
rent loss. Fortunately, I was completely coveredare: rent loss, market risk that not enough
for both physical damage and rent loss, othertenants will be available after construction is
than a small deductible. There is clearly nocompleted, cost of construction management, a
casualty loss I can claim as a tax deduction,illiquid market with few buyers just after the
right?"casualty, construction risk, interest rate risk (rates
Tax deductions are the basis for tax reduction.could rise during the construction period negatively
Tax deductions reduce taxable income but do notaffecting value), risk that operating expenses
directly reduce federal income taxes. Forcould increase during the construction period
example, $100,000 of tax deductions reduces(perhaps insurance) and compensation for
federal income taxes by $35,000 ($100,000 Xentrepreneurial effort to induce a buyer to
35%), assuming a 35% tax rate. Most taxcoordinate labor capital, management and
deductions require a cash expenditure (labor,compensation for capital during the reconstruction
material, supplies, utilities, etc). A current periodand releasing process.
cash expenditure is not required for some realA careful analysis by an appraiser might show the
estate tax deductions and may not be requiredimprovements have no value after the flood. In
for a casualty loss.appraisal assignments performed by the writer, a
Most real estate owners and investors do notcasualty loss of 10-30% of the market value
consider casualty losses as a source of taxbefore the casualty has occurred (in a
deductions. Few investors claim the casualty lossstraight-forward, defensible analysis) is typical. This
tax deduction the federal income tax code allowscan generate a meaningful casualty loss (and tax
them. Let's review the criteria for a casualty lossdeduction).
tax deduction and the thought process regardingFor example, a property with a market value of
acquisition of a property that has suffered a$5,000,000 suffers a 30% casualty loss. While the
casualty.casualty is a serious hardship for the owners, the
Real estate owners suffer a casualty loss when$1,500,000 ($5,000,000 X 30%) tax deduction will
the market value immediately after the casualtymitigate the financial loss.
plus insurance proceeds is less than the marketCongress provided a casualty loss tax deduction
value immediately before the casualty. Theto encourage investment in real estate. If you
complex issue is how to value the propertyhave the misfortune to suffer a casualty loss,
immediately after the casualty. Let's consider atake the helping hand offered by congress and
1-story suburban office park in Mississippi whichtake the tax deduction.
suffered 3-feet of flooding due to HurricaneClick here for a FREE preliminary analysis of
Katrina. Let's further assume: 1) 8 feet of sheetincome tax savings for your property.
rock must be replaced in the entire property toCost segregation produces tax deductions and
rebuild, 2) although the property was 90%reduces federal income taxes across the country
occupied before the flood, occupancy is expectedand in every size market. Below are just a few
to only be 5% while rebuilding occurs, 3) stabilizedexamples of cities where cost segregation
occupancy after renovation is not clear sincegenerates meaningful tax deductions.
some businesses may not return, 4) construction