Recovery with a Hand
from Uncle Sam
Few professional risk managers predicted or planned for the battering suffered by Florida-based businesses in 2004. Few businesses in the Gulf region could have predicted or obtained insurance against the tremendous damages produced more recently by Hurricane Katrina, Rita or Wilma. Fortunately, when risk management fails and insurance proves inadequate to cover a metal center operation’s losses, our federal tax laws are usually there to help ease some of the financial strain.

The havoc wrought by the hurricanes in the Gulf resulted in federal legislation, the Katrina Emergency Tax Relief Act of 2005, aimed largely at individuals impacted by the devastation of Katrina. That law permitted penalty-free withdrawal by service center owners from IRAs and other qualified retirement plans, funds that could be used to keep their businesses afloat. The law expanded the work-opportunity tax credit and the new-employee-retention credit. The law also extended the non-recognition of gain replacement period.

A second bill, the Gulf Opportunity Zone Act, allows effected businesses to claim 50-percent first-year depreciation on GO zone property. This “bonus” depreciation is allowed for property with a recovery period of less than 20 years, software, and both residential and non-residential real property.
The Section 179 expensing allowance was increased from the present $100,000 (with a $400,000 ceiling) to $200,000 (with a $1 million ceiling). To qualify, property must have been purchased after Aug. 28, 2005, and before Dec. 31, 2007, for use in one of the three opportunity zones created as a result of Hurricanes Katrina, Rita or Wilma.

The Internal Revenue Service did not wait for Congress and provided help in its unique manner. That help took the form of postponed deadlines for the filing of many tax and information returns as well as later deadlines for the payment of taxes by many of those affected.

However, it is our basic tax law, the Internal Revenue Code, which continues to provide the bulk of relief for metal distribution businesses and their owners—even those who suffer losses in areas that do not receive the publicity given recent disasters.

Casualty losses
Generally, the damage, destruction or loss of property resulting from an identifiable event that is sudden, unexpected or unusual qualifies as a “casualty loss.” Casualty losses are, of course, tax deductible—if the metal center operation’s owner or manager can prove that a loss occurred and can put a value on the amount of that loss.

Simply misplacing or losing property does not qualify as a tax-deductible casualty, even though an insurance company may consider it a reimbursable loss. Naturally, if property is lost in conjunction with another accident or casualty, it may qualify.

With casualty losses, the rules limit the tax deduction amount to the lesser of the difference between the fair market value of the property immediately before the casualty and its value immediately after, or the adjusted basis (book value) of the property immediately before the casualty.

Obviously, if the metals business or its property is totally destroyed, the amount of the casualty loss is the adjusted basis of the property regardless of its fair market value.

Also labeled as casualty losses are embezzled or stolen monies. The theft loss is the amount actually stolen. In the case of stolen business or income-producing property, the loss is the adjusted basis of the property stolen.

Proving the unthinkable
In order to claim a tax deduction for any casualty loss, it is often necessary to prove it. Specifically, if the operation’s income tax return is audited, it may be necessary to show all of the following:

• That the operation owned the property
  
• The amount of its basis or book value in the property
  
• The pre-disaster value of the asset
  
• The reduction in value caused by the disaster or other casualty, or
  
• The lack or insufficiency of reimbursement to cover the costs.
  

Naturally, for any metal center business to claim the casualty loss deduction, the property must be owned by the business. Therefore, the metals business cannot claim a loss for the destruction of property owned by a manager or employee. If more than one person owned the property, the loss is allocated among the owners in proportion to their ownership interests.

Remember, if a lease or rental agreement for property used in the business requires payment for any damages resulting from a casualty, then that loss, too, will qualify as a casualty loss.

Proving the book value or basis of business property is generally not a problem—if the operation’s records have not suffered a fate similar to the property lost. The tax-deductible loss is usually the property’s original cost plus any additions or subtractions to the basis made for tax or accounting purposes.

Although not specifically required by our tax rules, a professional appraisal is often the best evidence or proof of property value before and after a casualty. While professional appraisals are nice to have, they are not always required, especially with inexpensive items. An insurance adjuster’s appraisal may do just as well.

Gaining from a loss
Surprisingly, a number of metals distributors have profited from their casualty losses. If the amount of the insurance reimbursement received is more than the adjusted basis of the destroyed or damaged property, there may actually be a gain. Fortunately, the fact that a gain exists does not necessarily mean that it will be taxable right away. Most businesses are able to defer the gain to a later year (or perhaps indefinitely) if “qualified replacement property” is purchased.

In calculating that gain, any expenses incurred in obtaining the reimbursement, such as the expenses of hiring an independent insurance adjuster, are subtracted from the reimbursement. Then, if the same amount as the rest of the insurance money received was spent either repairing or restoring the property or in purchasing replacement property, tax on the gain may be postponed. Of course, the replacement must occur within two years of the end of the tax year the gain was realized.

The replacement property must be similar or related in use to the property destroyed. If the property was investment real estate, then other investment real estate will qualify as a replacement. If, however, the property was business or income-producing property located in a federally declared disaster area, any business-use property will qualify.

Disaster business losses
To help cushion losses suffered by service center operations, businesses and others, the tax laws contain a special rule for losses incurred from a disaster in an area subsequently determined by the president to warrant federal assistance. For those losses, the metal center owner or manager has the option of deducting the loss on the tax return for the year in which the loss occurred, or choosing to deduct the loss on the tax return for the preceding tax year.

In other words, the metals business has the option of deciding whether their loss would be most beneficial offsetting the current year’s tax bill or if used to reduce the previous year’s tax bill, generating a refund of previously paid taxes.

Temporary tax relief
Soon after Hurricane Katrina struck, and again after Hurricanes Rita and Wilma, the Internal Revenue Service announced that those affected were eligible for tax relief. What’s more, the IRS has assured everyone that it will continue monitoring the aftermath of the hurricanes and resolve other potential tax administration issues as they arise. In fact, taxpayers not in the covered disaster areas but whose books, records or tax professionals’ offices are in the covered disaster areas, are also entitled to relief.

Relief for all others is provided under our basic tax rules governing casualty losses. Those tax rules can go a long way toward helping ease the financial burden of many metals distributors resulting from an unexpected disaster.