A Not-So-Casual Look at Casualty Loss - Part 3
Loss and Non-Major Disasters
Part 1: Definition of casualty loss and where we find IRS guidance
Part 2: Casualty loss related to a presidentially declared major disaster
Part 3: Casualty losses that do not relate to a declared disaster
Part 4: IRS provisions designed to assist victims of major disasters
A reduction in qualified basis due to casualty loss that is unrelated to the declared major disaster is handled differently than loss resulting from declared disasters in two major ways:
1) The disallowance of credits.
2) The reasonable period to restore.
If the building’s qualified basis is restored within a reasonable period, the building will not be subject to the usual penalty called recapture. However, the owner cannot continue to claim credits on any units that are out of service due to the casualty event. A reasonable period for the restoration of the building’s qualified basis is 24 months from the end of the calendar year in which the casualty occurred. Note that, because entire calendar years are involved, this is almost always a greater time than the 25 months allowed for major disasters. Keep in mind, however, that this only relates to avoiding recapture. Unlike major disaster losses, tax credits cannot be claimed during the restoration period for non-major disaster related casualties.
Declared disaster loss rules are more favorable in that they do not disallow credits while the units are out of service. However, it is important to know that it is possible for a building suffering a reduction in qualified basis due to a non-declared casualty event not to lose any credits. This is because tax credits after the first year are determined for the entire year based on which units are habitable on the last day of the tax year. Therefore, if a building owner with a calendar tax year were to suffer a casualty loss early in the year and the restoration of the damaged units was completed prior to December 31, the owner can claim a full year’s credits on the restored units. Note that the units are not required to be necessarily inhabited on the last day of the year, but any vacant units on the last day of the year that were occupied by qualified tenants prior to the casualty event must be continually marketed to rent them to low-income tenants, per the tax credit Unit Vacancy Rule.
The unfortunate “flip-side” of the rule regarding the last day of the year is that, if the owner fails to restore the damaged units by end of the year end, no credits would be allowed on the units for the year. This is particularly painful for a property when a loss occurs late in the year and units cannot be restored in time. Although credits will be allowed upon restoration until the end of the building’s credit period, credits that are disallowed prior to restoration cannot ever be claimed. Clearly, prompt restoration of units, ideally within the tax year, is the best plan to recover from casualty events.
Question: Will an 8823 be filed for my damaged building before it is restored when a major disaster is not involved?
Answer: Yes. Any reduction in qualified basis must result in report of noncompliance to the IRS on form 8823. Official guidance allows that an 8823 resulting from major disaster casualty may not have to be submitted, if the rebuild is within a reasonable period. This is because there is no reduction in qualified basis. However, that does not apply to other casualty loss. However, a state is likely to clarify the situation with the IRS when they submit the 8823.
Casualty Loss NOT in a Declared Disaster
In March of 2018, a fire that is not related to a major disaster seriously damages a building. The owner’s tax year is a calendar year. If the building is restored by the last day of 2018, credits are allowed for all of 2018 and no recapture penalty will result. If the building is not restored by the last day of 2018, no credits can be claimed for the year, and the same is true with 2019 and 2020. Recapture, however, can be avoided for 2018 and 2019 by completing restoration in a reasonable period. The latest the building can be restored and avoid recapture in this case is December of 2020, or 24 months from the end of the calendar year in which the casualty occurred.
Note: although the maximum reasonable period is several months longer than the deadline for major disaster areas (which was April of 2020), the key difference is that credits cannot be claimed until the unit or building is restored after a non-declared loss.
Next week: Is it really true I can move in over-income people into tax credits who have been displaced by any casualty loss? And more!