The firestorm that hit the North Bay in October had huge consequences for many homeowners and businesses, including tax implications.
We interviewed Aaron Tompkins, a CPA and senior manager in the tax section of Moss Adams in Santa Rosa, about how to handle fire-related casualty losses using Form 4684. The Moss Adams building, the topmost structure of Fountaingrove Center on Round Barn Blvd., did not burn, but fire scorched trees and landscaping next to it. Moss Adams was unable to use the space for more than three weeks.
Your building has been cleaned of smoke damage after the fire?
Yes. About every 30 seconds we hear trucks rumbling down full of debris. It’s nonstop. I’m surprised how quickly they have worked. I expected it to take longer. The magnitude — there is so much to be done.
Fire victims have casualty losses. How should business and property owners handle those losses on Form 4684?
It’s not a super-difficult form. If a business has equipment, a car, a building, the first step is to figure out if you have a casualty gain or loss.
A gain would be if insurance covered more than the basis in the property?
Exactly. To make that calculation, basis (amount paid for property) is important. If the insurance reimbursement is more than the basis, it’s a gain and you’re done. If insurance proceeds are less than the basis and the property was not fully destroyed, then you have to figure fair-market value before and after the fire. The deduction is the lesser of the drop (in value between current value after fire and either basis or market value before fire, minus insurance payout). You can never deduct more than your basis.
Your clients have received insurance?
Insurance has been very responsive. People are already getting insurance reimbursements. Claims are being paid.
Has anyone come to you and asked about tax repercussions?
Yes. We have a number of clients who were affected, more homeowners than businesses. On the business side, it’s primarily clients with rental property in Fountaingrove or Coffey Park. We have quite a few. Most had sufficient insurance. They’re going to be on the casualty-gain side. They have to figure out if they’re going to keep the cash and pay tax, or reinvest.
Roll it over?
Exactly. The tax code has rules that apply to casualty gains that will get you out of that tax for now. You can roll it into replacement property. On the business side, rules are very favorable. You don’t have to roll it into something exactly the same.
Just roughly comparable?
Yes. In a federally declared disaster area, which this is, you have to reinvest in other business property under Section 1033. Normal rules that would apply to a 1031 exchange are relaxed in a federally declared disaster area. You have business property that was destroyed, insurance reimbursement comes in. If there’s a gain, you can invest in totally different business property.
How far does that latitude go? At what point would the IRS object to the replacement property?
I don’t have anybody pushing that envelope as long as they’re reinvesting in the business.
Declaration of a federal disaster area allows a fire victim to file a claim retroactively with revision of 2016 taxes?
Exactly. Once we figure out we have a loss, we can take that loss on upcoming 2017 tax returns or, because we’re in a federally declared disaster area, go back and amend 2016 returns. We get to pick.
Can a fire victim roll the tax loss forward if there was not enough income to offset it?
Let’s say you decide to amend the 2016 return and you’re able to totally wipe out income and create a loss. You can carry the loss back two more years, to 2015 and 2014, use those deductions against that income. If you are a small business with less than $5 million of average annual gross receipts or a farming business, you can carry back three years (including 2013). The event occurred in 2017 but you’re able to go back a number of years.
It’s very flexible?
Yes. In order to be a disaster area, it has to be a big event.
What is that threshold?
I don’t know if there is a specified threshold. It is presidentially declared. I assume it is discretionary. Once it’s declared, another set of rules kick in, especially on the business side. There are no limitations on disaster losses. On the gain side you have the ability to reinvest and expand what you can invest into with replacement property. You defer that gain. You have some basis issues on the reinvestment. If you had a piece of machinery worth $500,000, totally destroyed, and you got a $600,000 insurance reimbursement.
You have a $100,000 gain?
Yes. You invest that $600,000 into new machinery. Under normal rules, you would have $600,000 of basis. But when you are deferring gain (insurance from a casualty), you have to reduce your basis to what it was before ($500,000). The rules are trying to put you in the same position as you were before.
Is there a difference in how you calculate the loss — whether it’s derived from basis or fair-market value before the fire?
There is a tricky area. You are supposed to do this property-by-property.
Instead of as a whole? Each one is an individual loss or gain?
Yes. Determine the basis for each property, the change in fair-market value, the insurance reimbursement. Form 4684 has individual lines for each property. You sum together each item rather than doing it in aggregate. You can end up with different results than you might think.
That applies to both personal and business property?
Yes. The way you go about it is a little different. With homes, for example, the home is the main structure. What’s around it, the shrubbery, it’s all one property. For business, each thing is separate.
What about mixed-use property, such as a home-based business?
In that case, you’re supposed to carve out the business portion from the personal portion and then run the calculations that way. On the business side, if you have a loss, you get to take the loss. Simple. The math is not hard. On the individual side, if you have a loss, once you sum up the losses then you have to reduce the total by $100. When the rules came into play, I imagine $100 was worth more than it is today.
In addition, you reduce it by 10 percent of your adjusted gross income. If you have decent insurance, then your loss may not be a huge number. (The rules) can cut up that loss pretty quickly. You have to itemize your deductions. On the personal side, this is not as good of a deal as on the business side.
In mixed use, the proportionality would be the same as used in proportioning a home office?
Yes. If it is a home, do it based on square footage. You wouldn’t deviate from what you used (in a home office).
The adjusted basis is the acquired cost plus improvements minus depreciation?
Correct. For business property, this is an easier exercise if people keep good books and records. We have depreciation schedules. Every asset is listed there. We track that. With personal property, most people have to re-create.
They don’t know the wear-and-tear loss of value?
Yes. To figure fair-market value before and after (the fire) and comparing that to basis, if I bought something 10 years ago, I probably don’t know what I paid for it. Likely I don’t have receipts. What was it worth beforehand (fire). What would a willing buyer pay. Our clients have had good insurance and are in the other position — the casualty-gain side. They are planning on reinvesting.
In the Fountaingrove district, most people were well insured?
At least the ones I have worked with, that’s what I’m experiencing.
Beyond the financial loss, the interruption to life for a business owner or leader spills over into everything else?
It does. Other partners here probably have clients who were underinsured as well. Most people don’t check their insurance coverage for years.
What’s it like being in your building, which survived the fire, yet you drive past Fountaingrove Inn and the Hilton hotel, both obliterated?
It’s crazy. You go two directions from the office — up Fountaingrove or out Old Redwood Highway — the devastation is incredible. If you go left instead of right, you would never know there was a fire.
You see a few darkened trees, but that could have been drought?
Yes. It could be time of year, winter. It’s very weird. I drive up every day. The buildings are burned, the landscaping around our building, burned. We are right on the line. If I look out my window, I would think it’s a normal time. Look out one of the other windows in the building, you would think a bomb went off. It’s very odd being on the line where the fire stopped.
Did it smell in here when you first came back to work?
We were displaced from this building for three weeks. Utilities did not work for a long time. By the time the office-at-large got back, you couldn’t really tell. The first people in here said it reeked of smoke. They had carpets cleaned, brought in big fans to blow out the air. They did a good job.
You had temporary sites for Moss Adams?
One was in Petaluma. We had a client graciously offer a portion of their unused space near Sebastopol for two weeks. This office has about 80 full-time people. About half were in those locations, the rest working from home.
Was the fire a major interruption to Moss Adams in terms of business functioning?
October 15 is a major deadline for our tax practice and assurance practice, benefit-plan audits. Horrible timing. On the income-tax side, we got an extension until January 31. You can file anything that was originally due on Oct. 15 by Jan. 31, personal or business tax returns. We had some clients where their records were destroyed on top of emotionally dealing with the fires. For those folks, we use the extra time.
Time to reorganize themselves personally?
When a person has lost his or her home, how efficient is the IRS at getting tax records needed to reconstruct a life?
They’re fairly efficient. If there’s a casualty loss and an amended return (on a previous year,) a refund will come pretty quickly. Federal is better than state — much, much, much, much better.
The retroactive feature of this law, a refund of taxes paid, becomes a quick way to get a chunk of money?
It is. You have to factor in estimated insurance recovery. You can’t ignore insurance in the calculation. Make a good-faith effort (then adjust it later.) It’s a way any folks who were underinsured can get some dollars back.
For people who lost homes and their records are gone, how do they reconstruct?
You do the best with what you have. In the digital age, records are largely saved electronically. It’s somewhere in the cloud, bank statements, W-2s.
Technology has changed the nature of financial loss with records in the cloud?
Yes. So long as you are using it (backup to the cloud). On the business side, generally you should be able to recover (documents) from the last several years. On the personal side, receipts might not be in the cloud. If you held property for years, it might be hard to recreate basis when paper documents were destroyed and never scanned. A lot of individual taxpayers don’t have all their records in pristine order.
You are used to fuzziness?
Exactly. We make sure it looks and smells right. Often we are getting people’s best estimates. That’s how they conduct their financial affairs.
There’s quite a range of personalities in how people deal with numbers and details?
Exactly. Whether it’s a casualty loss or anything else, they will have details at the level based on who they are.
With business owners, have you had people ask for help who are so overwhelmed by fire-related loss that they are functioning at a very low level?
I have had some folks it has definitely taken a toll on. You can see it on their faces. Not just that they lost a lot of stuff, but dealing with the emotional (aspects). There are a lot of things to take care of when something like this happens, on top of making sure the business runs — the additional stress. It’s almost as if they have another job just to work through all this.
They are still functioning well, but they have good folks in the business working for them as well. They are not sole (proprietors) doing everything in the business. Other people can step up and help get things done.
Are these business owners feeling disoriented by trauma?
If they had their homes burned, most people I am dealing with are in another place now. Some are staying with family or have been put into longer-term rental situations. But they’re not in the same neighborhood. Some are miles and miles from where they were before.
Everything is different. Your neighbors aren’t who you’re used to. Your drive to work isn’t the same. Nothing is familiar in addition to loss of memories in the fire. You have all these chores and tasks you have to do. If you’re a business owner, you have to be thinking about employees going through the same thing. It is a lot. People persevere.
Are businesses more suited to survive an event such as fire than individuals?
On the business side, there is devastation. It’s horrible, but businesses are set up to carry on when things happen. You have multiple people involved, backup systems.
There’s a consciousness of redundancy?
I have not thought about it in those terms, but that’s correct. We don’t live our personal lives with the same level of consciousness as we do in business.
Businesses are not supposed to be risk-embracing to the same extent?
Agreed. On the personal side, people don’t even think of it as risk. They’re just living their lives. Everybody knows that they ought to back up their computers, check their insurance. But the ‘ought to’ doesn’t always translate into ‘do.’
They’d rather watch a movie?
In business as an owner, there’s a sense of responsibility, especially if you have many employees. They think about other people’s lives, careers and families that are dependent on the owner? The business is designed to endure?
Yes. There is a lot of redundancy in business that we don’t build in outside of that, especially for older folks who might not have had the technology. If you are twenty-something, you probably do some of those things without necessarily intending to. It’s what you know. Technology is part of your life. Your transactions are largely done electronically. There is a record of those transactions.
For younger persons, there is less to burn?
A lot of people make purchases through their iPad or phone. When you buy a home, you use DocuSign (San Francisco company, electronic signatures). Everything is digital. If you need a copy, the bank or title company has it.
The whole issue of casualty losses is shifting and declining based on technology, especially as we go further into the cloud?
Yes. In a business context, if you have a total loss, the fair-market value before doesn’t matter. You’re just looking at the basis. As a person, fair-market value still factors in even if it’s a total loss. You have to know fair-market value before and after (fire). That’s what could be questioned by the IRS — what is that drop in value. Even if records are digital and you can support original cost, you wouldn’t necessarily know the value immediately before (the loss).
But having records digitally gets around having everything in a safe burn up, as long as the digital record wasn’t saved on a backup drive that was in the safe, and also burned in the fire.
James Dunn covers technology, biotech, law, the food industry, and banking and finance. Reach him at: firstname.lastname@example.org or 707-521-4257