By Robert J Bruss of the Washington Post (Real Estate Mail Bag)

Editor's note: According to a recent update to IRS Fact Sheet 2006-12, homeowners affected by hurricanes Katrina, Rita and Wilma need not be concerned about the casualty loss of 10 percent of adjusted gross income or the $100 per event floor limitations. The special rules apply only to the recent hurricane victims, not to the vast majority of individuals who encountered other casualty losses.

Regrettably, 2005 was a record year for both insured and uninsured real and personal property losses. Hurricanes, floods, firestorms and other "sudden, unusual or unexpected" events caused millions of dollars of uninsured losses.

For example, the thousands of homeowners who lost their homes in Hurricane Katrina and Rita due to flooding, but who didn't have flood insurance, will be able to deduct most of their losses on their income tax returns.

For partially insured casualty losses, the good news is Uncle Sam wants to share the loss by allowing income tax casualty loss deductions for the uninsured portion. Even if you didn't personally suffer such a loss last year, it pays to understand casualty losses for possible future use.

WHAT LOSSES ARE TAX DEDUCTIBLE? Uncle Sam defines a tax-deductible casualty loss as an uninsured "sudden, unusual or unexpected" loss event. To qualify for this tax deduction, at least part of the loss must be uninsured. If your loss was fully paid by insurance payments, then you don't have a casualty loss tax deduction.

Examples of fast-occurring casualty loss events include hurricane, fire, flood, earthquake, tornado, mudslide, theft, accident, riot, embezzlement, vandalism, water damage, snow, rain and ice damage.

When the president declares a disaster area, such as a major flood, fire, earthquake or hurricane, taxpayers who suffered uninsured casualty losses then have a choice of claiming their deductions either in the tax year of the loss, or in the previous tax year by amending their prior year tax returns to claim a tax refund.

THE LOSS MUST OCCUR QUICKLY. Casualty loss tax deductions are only allowed for uninsured losses that occurred quickly, usually instantly or over a few days. Losses that occurred slowly over several years or months, such as dry rot or termite damage, are not tax deductible.

Examples of losses that usually occur too slowly to qualify include rust, dry well, corrosion, moth damage, Dutch elm disease, erosion, drought, mold, dry rot, termite damage, beetle infestation, plant loss, and tree death.

PERSONAL CASUALTY LOSSES ARE NOT FULLY DEDUCTIBLE. If a sudden and uninsured casualty loss affected your business property, it is fully tax deductible as a business expense. However, if your uninsured casualty loss did not involve business property, then only part of your loss is tax deductible.

The reason is only uninsured personal casualty losses exceeding 10 percent of the taxpayer's annual adjusted gross income (line 37 of your
2005 federal tax return), minus a $100 non-deductible "floor" per event, are deductible.

To illustrate, suppose Hurricane Katrina made your home and you didn't have flood insurance. Before the flood, your house was worth $250,000 but after the flood all you have left is land value of about $50,000.
You paid $225,000 for the house when it was purchased a few years ago.
Let's also suppose your adjusted gross income for 2005 is $40,000.

Use Internal Revenue Service Form 4684 to calculate your deductible casualty loss. Although the house in this example was worth $250,000 before the flood, your casualty loss is limited by the $225,000 adjusted cost basis, minus the $50,000 remaining land value, or $175,000. From that amount, subtract the 10 percent of AGI nondeductible portion
($4,000) and the $100 per event floor to arrive at an approximate $170,900 deductible casualty loss. In addition, the value of uninsured personal property also qualifies for this tax break.

INDIRECT EXPENSES ARE ALSO DEDUCTIBLE. In addition to the casualty loss deduction for real and personal property, indirect casualty loss expenses that were not paid by insurance also qualify for this generous deduction.

Examples of deductible indirect costs include temporary housing, moving expenses, and property protection such as board-up and legal expenses.

HOW INSURANCE PAYMENTS AFFECT CASUALTY LOSS DEDUCTIONS. The casualty loss tax rules require insured property owners to file claims for any insured losses with their insurers. However, in the last few years many insured home and business owners have become reluctant to file insurance claims of small amounts for fear of policy cancellation or greatly increased premiums. So far, there is no evidence the IRS has denied casualty loss deductions for failure to file insurance claims.

But, especially on larger policy claims, when the insurance payment to the insured exceeds the property's adjusted cost basis, if the insurance money is not used to replace or rebuild, then the taxpayer has received taxable income on the excess insurance payment amount.

However, this rule does not apply to insurance payments for damaged or stolen personal property because excess insurance money exceeding the adjusted cost basis of personal property is not taxable even if the items are not replaced.

Taxpayers in federal disaster areas, such as those affected by recent hurricanes and floods have up to four years to reinvest their insurance payments in repairs or replacement property to avoid owing capital gains tax on excess insurance payments.

THE I.R.S. LOVES TO AUDIT CASUALTY LOSSES. Because some casualty loss claimants overstate their deductions, the IRS often audits casualty losses that cannot be proven. With adequate proof of loss, taxpayers have nothing to fear. Repair bills and receipts are superb evidence to support a casualty loss deduction.

But repair estimates alone usually are not enough. Further evidence of the casualty loss amount might include police reports, photos of the damaged or lost property, and before and after appraisals.

However, as explained earlier, the casualty loss deduction is limited by the taxpayer's adjusted cost basis for the destroyed or damaged property. Market value at the time of the loss is irrelevant.

SUMMARY: If you suffered an uninsured "sudden, unusual, or unexpected"
casualty loss that exceeds 10 percent of your adjusted gross income, minus a $100 per event "floor," Uncle Sam can help share your loss in the form of the casualty loss tax deduction. For full details, please consult your tax adviser.

Next week: Residential moving cost tax.

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by Attorney William Bronchick

There has been a lot of negative press and misinformation lately about double-closings. Many people have been indicted recently under what the press has labeled "Property Flipping Scams." Misinformed lenders, real estate agents and title companies will tell you that double-closings are now illegal. In fact, they are nothing of the sort.

A double closing is simply two back-to-back closings wherein the proceeds from the second closing is used to fund the first closing. Both closings are done in escrow so that the "middleman" can buy and resell a property for profit without using any of his own cash. The middleman profits because he buys the property below market and resells it for market price. This process has been done tens of thousands of times over the last 100 years - legally, ethically and PROFITABLY!

The so-called "illegal property-flipping schemes" work as follows: unscrupulous investors buy cheap, run-down properties in mostly low-income neighborhoods. They do shoddy renovations to the properties and sell them to unsophisticated buyers at inflated prices. In most cases, the investor, appraiser and mortgage broker conspire by submitting fraudulent loan documents and a bogus appraisal. The end result is a buyer that paid too much for a house and cannot afford the loan. Since many of these loans are insured by the Federal Housing Authority (FHA), the government authorities have investigated this practice and arrested many of the parties involved.

Despite the negative press, neither flipping nor double-closings are illegal. The activities described above simply amount to loan fraud, nothing more. Newspapers have inappropriately reported the activity as illegal "property flipping," rather than simply "loan fraud." So, whenever you hear a real estate agent or mortgage broker say, "flipping is illegal", you know they are misinformed.

The misunderstanding of the flipping business has not been without consequence. Many title and escrow companies simply will not do a double-closing. Fortunately, there's many that still do double closings, but they are also keeping a close eye on potential fraud (as they should).

Some lenders have placed "seasoning" requirements on the seller's ownership. If the seller has not owned the property for at least six months, the lender will assume that the deal is fishy and refuse to fund the buyer's loan. This may be a problem if you bought a property cheap and are reselling it quickly for a profit (the good, old American way!). This should not be confused with LAW - it is simply an underwriting guideline for some lenders. Of course, guidelines are just that - by going up the chain of command, you can generally get approval from loan underwriting by showing the property is being resold for a higher price because either it was purchased in a distress situation (e.g., foreclosure) or that substantial repairs were made. Keep good records of your repairs to show to the lender.

If the buyer is getting an FHA insured loan, there is no way around the "seasoning" issue. FHA regulations prohibit the funding of a purchase where the seller has not owned the property for at least 90 days, NO EXCEPTIONS. This generally should not be a problem in a fix-and-flip situation, since it will likely take you 90 days by the time you acquire, rehab and sell. But, if you are planning on buying the property and reselling it in a double-closing, the end-buyer CANNOT go with an FHA loan.

BRONCHICK'S RULE #14:
ALWAYS REMAIN IN CONTROL OF YOUR DEALS!

A smart investor should stay on top of the process and anticipate these issues. If you are buying a property and reselling it quickly, particularly in a double closing situation, you must anticipate this problem and deal with it. Let the buyer, his real estate agent and his lender know that there may be a seasoning issue. If you stay in control of the loan process and steer your buyers to a mortgage company that doesn't have a hang-up with double-closings, then seasoning won't become an issue. Generally speaking, only FHA and subprime lenders have the "seasoning hang up" - FNMA underwriting guidelines do not prohibit funding a purchase money loan where the seller has not owned the property for a minimum period of time.

If you do get into a last-minute jam in a double-closing situation, there is a solution, which is called a "reverse assignment". You simply assign your contract with the end-buyer back to the owner and step out of the deal. Your "consideration" for doing so, is the profit you would have otherwise made. This consideration can be documented in writing and secured by a lien on the owner's property to be paid to you at closing.