Tax relief measures are available for individual taxpayers impacted by the Los Angeles County wildfires and offer potential deductions and gain deferrals for personal casualty losses. From casualty loss deductions to gain deferrals, understanding these tax rules is essential for maximizing recovery.
BACKGROUND
As Angelenos look to recover what was lost in the January wildfires, there are a variety of tax relief measures that can provide timely and crucial financial assistance.
On Jan. 8, 2025, President Biden signed a Major Disaster Declaration related to the wildfires impacting Los Angeles County. The declaration of a federally declared disaster is critical for individual taxpayers in the impacted area to qualify for casualty loss or gain treatment for their damaged personal-use property.
WHAT IS A CASUALTY?
A casualty is defined by the IRS as “the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected or unusual.” When a federal disaster declaration is made, such as the one issued for the January 2025 Los Angeles wildfires, it opens the door for individual taxpayers in the affected areas to claim special tax treatment related to their impacted personal-use real or personal property. Personal-use real property includes a taxpayer’s real property (such as houses and land) that is not used in a trade or business, and personal property would include all other property such as artwork, vehicles, jewelry and personal effects. Both federal and California tax law provide similar relief treatment for taxpayers experiencing gains or losses because of a casualty.
HOW IS A CASUALTY LOSS CALCULATED?
For personal use property the amount of casualty loss is initially determined by the lesser of the adjusted basis of the property, or the decrease in fair market value of the property because of the casualty (i.e., the difference between the fair market value of the property immediately before the casualty and the fair market value immediately after the casualty). In effect, a deduction for a casualty loss has a ceiling, which is the taxpayer’s adjusted basis in the property. The amount of a casualty loss is then further reduced by any insurance claim proceeds or other reimbursements received in relation to the property. Taxpayers with insurance or reimbursement proceeds that exceed their adjusted basis in their damaged property may experience a casualty gain.
For example, an impacted taxpayer whose house, originally purchased for $500,000 but has since increased in value, is damaged by a wildfire. The fire causes the property’s value to drop by $700,000. Their insurance company pays them $300,000.
To figure out their loss, one first looks at the smaller of two numbers: the taxpayer’s adjusted basis in the house of $500,000 or the decrease in fair market value of $700,000, whichever is less. In this case, it is $500,000.
Then, subtract the $300,000 of insurance proceeds from the $500,000. This results in a casualty loss of $200,000.
CALCULATING CASUALTY GAIN
If the same taxpayer had a larger insurance policy, this could change the outcome. For example, instead of receiving $300,000 from the insurance company, the taxpayer gets $1,000,000. This would cause the insurance proceeds of $1,000,000 to be more than the taxpayer’s adjusted basis in the property of $500,000. When this happens, the taxpayer has a casualty gain. The gain is calculated as the insurance proceeds of $1,000,000 less the taxpayer’s adjusted basis in the house, which results in a $500,000 gain.
PERSONAL-USE REAL PROPERTY CALCULATIONS
If a single casualty event involves more than one item of property, the casualty gain or loss must be computed separately for each item of property, except for personal-use real property.
For personal-use real property, the entire property (including land, improvements, trees, etc.) is treated as one item. Once the casualties on all impacted property have been computed, the amounts are netted together to compute the taxpayer’s net casualty gain or loss for the year. A net casualty loss will create an ordinary deduction, whereas a net casualty gain will be treated as a capital gain and taxed at favorable capital gains rates.
PITFALLS TO BE AWARE OF
If a net loss arises from casualty, there are restrictions on the amount a taxpayer may deduct. First, the first $100 of loss from a casualty cannot be deducted. The loss is reduced by $100 per casualty (such as the LA Wildfires), not $100 per item or $100 per year.
Second, after the amount of the loss is reduced by $100, taxpayers may deduct only the net casualty loss (i.e., the excess of all personal casualty losses for the tax year over all personal casualty gains for that tax year).
Third, after applying the first two limits, taxpayers may deduct only the portion of the net casualty loss that is greater than 10 percent of their adjusted gross income for the tax year.
To substantiate the amount of a casualty loss deduction, the taxpayer must establish all of the following:
- The adjusted basis of the asset involved
- The decline in value of the property because of the casualty
- The amount of any reimbursement
Taxpayers should seek professional assistance in determining their casualty gains and losses as the burden of proof rests with the taxpayer. Casualty loss deductions are often denied because taxpayers cannot establish the additional facts needed to allow the deduction, such as a resulting decline in the fair market value and/or the adjusted basis of the asset.
REALIZED CASUALTY LOSSES: RECOGNITION AND ACCELERATION
For both federal and California tax, a taxpayer may elect to claim the casualty loss deduction either in the year the loss was incurred or the prior tax year through the filing of an amended return. For individual taxpayers affected by the fires, the disaster year will be 2025, and they can elect to claim the disaster loss in either tax year 2024 or 2025. Claiming the casualty loss in the prior year may allow the taxpayer to receive a refund more quickly, however taxpayers should consult with their tax advisors to determine which tax year provides the maximum benefit.
Additionally, the year a casualty loss is incurred may impact the calculation of a taxpayer’s net operating loss for the year. A personal casualty loss, if large enough, can generate a net operating loss that may be carried over to the following tax year. For California taxpayers, net operating loss carryovers for taxpayers with adjusted gross income in excess of $1 million have been suspended through tax year 2026; however, the deduction for a disaster loss is excluded from this limitation. Therefore, if a disaster loss results in a net operating loss for California tax purposes, that net operating loss may be carried forward and potentially utilized through 2026, regardless of the taxpayer’s adjusted gross income.
REALIZED CASUALTY GAINS: EXCLUSION OR DEFERRAL
IRC Sections 121 and 1033 provide opportunities for taxpayers to exclude or defer realized casualty gains. IRC Section 121 contains the rules for the exclusion of gain from the sale of a principal residence. Involuntary conversions such as the destruction or condemnation of a property can be treated as a sale. Los Angeles County wildfire victims can claim up to a $250,000 (single or married filing separately) or $500,000 (married filing jointly) gain exclusion under this section for their primary residence.
IRC Section 1033 provides the rules for the deferral of gain from an involuntary conversion. Los Angeles County wildfire victims whose primary residences were damaged can defer their gains by acquiring replacement property. These taxpayers have up to four years from the end of the year in which they first received proceeds to acquire replacement property.
The underlying rules or IRC Section 121 and 1033 can be complex, please consult a tax advisor for further information.
RETIREMENT PLAN DISTRIBUTIONS AND IRAS
A taxpayer whose principal residence is in Los Angeles County, and who sustained an economic loss by reason of the qualified disaster, is eligible to receive up to $22,000 as qualified disaster recovery distributions from employer retirement savings plans, such as Section 401(k) and 403(b) plans or IRAs, without being subject to a 10-percent early withdrawal penalty.
However, the qualified disaster recovery distributions will generally be included in taxable income in equal amounts over a three-year period, starting with the distribution year, unless the taxpayer elects to include the entire distribution as income in the distribution year. For example, a qualified disaster recovery distribution taken in 2025 would be included in income ratably over the three-year period of 2025 through 2027, unless the taxpayer elects on Form 8915-F to include the entire distribution as income only in 2025.
Alternatively, the individual may repay all or part of the amount of a qualified disaster recovery distribution within the three-year period beginning on the day after the date that the distribution is received. If the individual repays a qualified disaster recovery distribution, the distribution will not be included as income for federal income tax purposes.
RETIREMENT PLAN LOANS
As a result of a qualified disaster, employers may increase the maximum retirement plan loan amount available to qualified individuals. Normally, employee retirement plan participants can access the lesser of 50 percent of their vested balance or $50,000. But following a major disaster, such as the Los Angeles County Wildfires, an employer may increase the dollar limit for plan loans up to the full amount of the individual's vested benefit under the plan but not more than $100,000 (minus outstanding plan loans of the individual). Loan repayments due from the disaster’s incident period and up to 180 days afterward may also be temporarily suspended for up to one year.
CONVERTING A TRADITIONAL IRA TO A ROTH IRA
Taxpayers that experience casualty losses may want to consider offsetting the allowable loss with the conversion of a traditional IRA to a Roth IRA. In certain circumstances, when a casualty loss significantly decreases the marginal tax rate, this conversion may be beneficial.
DISASTER RELIEF PAYMENTS
Qualified wildfire relief payments encompass compensation for losses, expenses or damages resulting from a qualified wildfire disaster, provided they are not covered by insurance or other reimbursements. These payments may include, for example, assistance for essential living expenses, temporary housing and funds for repairing damage. However, taxpayers cannot receive a double benefit for any expenses excluded from income. For example, if these qualified payments are used to acquire or improve property, the taxpayer cannot increase the property’s basis or deduct the related costs on their tax return.
Navigating the tax implications of wildfire losses can be complex, but understanding available relief options can make a significant difference in financial recovery. From casualty loss deductions to gain deferrals, strategic tax planning is essential for maximizing benefits. If you have been affected by the Los Angeles County wildfires and need guidance on how these tax provisions apply to your situation, GHJ is here to help.
Contact GHJ today to discuss your options and ensure you are making the most of available tax relief measures.
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