Tax Relief Roadmap

A roadmap to disaster area tax relief in 2008 legislation

Mike Habib, EA

The 2008 calendar year has seen more than the usual share of natural disasters in the U.S., and legislation designed to provide tax relief to the victims. By and large, legislative relief has been granted on an ad-hoc basis, with an attempt made in the last go-around (tax provisions included with the Emergency Economic Stabilization Act of 2008, referred to here as the Bailout Act, P.L. 110-343) to provide “national” disaster relief. Inevitably, there are some overlapping tax relief provisions and as-yet unanswered questions on the scope of the relief and the interplay between national relief provisions and other relief provisions. This Practice Alert, to be issued in several parts, provides practitioners with a roadmap to disaster-related provisions that may provide significant tax relief to their business and individual clients.

Background on recent disaster relief legislation. Congress started down the path to “targeted” tax relief for disasters back in 2005, in the wake of the devastation caused by Hurricanes Katrina, Rita, Wilma. It enacted the “Katrina Emergency Tax Relief Act of 2005” (KETRA, P.L. 109-73), which provided tax relief to hurricane victims through provisions that did not amend the Internal Revenue Code, and the “Gulf Opportunity Zone Act of 2005” (GO Zone Act, P.L. 109-135), which broadened the tax relief available to the hurricane-ravaged Gulf region through a series of new Code Sections (Code Sec. 1400M through Code Sec. 1400T). Some types of GO Zone relief were extended for the hardest-hit areas by the Tax Relief and Health Care Act of 2006 (TRHCA, P.L. 109-432). Early in 2008, in the “Food, Conservation, and Energy Act of 2008” (Farm Act, P.L. 110-234), Congress extended many of the Gulf area relief measure to the Kiowa, Kansas, presidential disaster area.

Finally, in Title VII (“Disaster Relief”) of the Bailout Act, Congress amended the Code to provide tax relief for victims of presidential disasters anywhere in the U.S. during 2008 and 2009, and extended GO Zone Act and KETRA relief provisions to apply to victims of presidentially declared disasters in ten Midwest states. To complicate matters further, the Midwest disaster tax relief is two-tiered: one set of relief provisions applies to the hardest hit areas; and the other set applies to a broader range of presidential disaster areas in the Midwest.

New Tax Relief for Victims of Disasters

The Bailout Act introduced a new series of tax breaks for disaster victims, all of which relate to a new term in the Code–“a Federally declared disaster.” This new term, in Code Sec. 165(h)(3)(C) , is “any disaster subsequently determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.” The term “disaster area” is defined as “the area so determined [by the President] to warrant such assistance.” The new tax breaks apply for disasters declared in tax years beginning after Dec. 31, 2007, for federally declared disasters occurring before Jan. 1, 2010. For businesses, the breaks consist of bonus depreciation, a bigger expensing allowance under Code Sec. 179, expensing of qualified disaster expenses, and a longer NOL carryback. For individuals, the breaks consist of eased casualty loss rules and a new casualty loss deduction for non-itemizers.

Observation: The scope of “a Federally declared disaster” isn’t clear from what passes for a Committee Report to the disaster provisions (JCX-73-08, the Joint Committee on Taxation Staff’s Technical Explanation of H.R. 7006, the “Disaster Tax Relief Act of 2008”) and to date has not been explained by IRS.

Stafford Act assistance for disasters. When the President makes a declaration under the Stafford Act, relief may be provided under Sec. 401 of that Act, relating to major disaster declarations, and Sec. 502 of that Act, dealing with Emergency declarations. (CRS Report for Congress: Robert T. Stafford Disaster Relief and Emergency Assistance Act: Legal Requirements for Federal and State Roles in Declarations of an Emergency or a Major Disaster, RL33090, September 16, 2005)

Under Sec. 401, the Federal Emergency Management Agency (FEMA) is empowered to activate three different programs to designated areas, depending on the need and the damage sustained. In descending order of importance, they are:

  • Level (1) individual assistance (aid to individuals and households);
  • Level (2) public assistance (aid to public, and certain private non-profit, entities for certain emergency services and repair and replacement of damaged public facilities); and
  • Level (3) hazard mitigation assistance (funding for measures designed to reduce future losses to public and private property). (FEMA’s “Guide to the Disaster Declaration Process and Federal Disaster Assistance”)

For example, as per the presidential disaster declaration of Nov 13, 2008, for Missouri, on account of severe storms, flooding and tornadoes that occurred on Sept. 11-24 (FEMA-1809-DR), 15 counties and the city of St. Louis are eligible for individual assistance. Forty-seven counties are eligible for public assistance and the entire state is eligible for hazard mitigation assistance.

Key question: For Missouri (as well as all other states that endured presidentially declared disasters in 2008 resulting in three different levels of assistance), what portion of the state is a “federally declared” disaster area?

Although a definitive answer will have to await IRS’s interpretation, it appears as if a “federally declared” disaster area may encompass only those areas entitled to Level 1 (individual) FEMA assistance. In other words, in our example of Missouri, above, only 15 counties and the city of St. Louis would be treated as a “federally declared” disaster area.

Observation: Many areas would be entitled to relief even if a “federally declared” disaster area is defined in this fashion. For example, to date, more than 450 counties and parishes in a total of 18 States (and Puerto Rico) have been declared to be eligible for Level (1) individual assistance from FEMA in 2008.

Federally declared disaster vs presidentially declared disaster. Before the Bailout Act, former Code Sec. 1033(h)(3) (dealing with the Code Sec. 1033(h) special involuntary conversion rules for principal residences affected by a disaster) defined a presidentially declared disaster as “any disaster which, with respect to the area in which the property is located, resulted in a subsequent determination by the President that such area warrants assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.” The regs carrying the filing and payment relief rules for disaster victims define the term covered disaster with reference to the definition of a presidentially declared disaster area in former Code Sec. 1033(h)(3). (Reg. § 301.7508A-1(d)(2)) And each of IRS’s notices of disaster-area relief under Code Sec. 7508A, as published on its website, apply only to those counties declared to be presidential disaster areas qualifying for individual assistance.

Code Sec. 1033(h)(3) now uses the term federally declared disaster as defined in Code Sec. 165(h)(3)(C). Because the prior law definition is similar in a functional way to the definition of a federally declared disaster, see above, it seems likely that IRS will interpret the new term (federally declared disaster) as synonymous with the prior law term (presidentially declared disaster).

Observation: If the two terms are indeed interpreted to be synonymous, it’s unclear why Congress deliberately chose to delete the old definition in Code Sec. 1033 and insert a new definition in Code Sec. 165.

Interplay with Midwestern disaster area relief. Under Act Sec. 712 of Division C of P.L. 110-343, the new tax provisions for federally declared disasters do not, by and large, apply to “any disaster described in section 702(c)(1)(A) [should read section 702(b)(1)(A)], or to any expenditure or loss resulting from such disaster.” The term “any disaster described in section 702(b)(1)(A)” refers to the counties of ten Midwest states (Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska and Wisconsin) that were declared to be major disaster areas by the President on or after May 20, 2008, and before Aug. 1, 2008, on account of floods, severe storms, and tornadoes in any of the ten Midwest states. There are two exceptions to this rule. The bonus first year depreciation allowance and increased Code Sec. 179 expensing for qualified disaster expenses (to be covered in a subsequent part of this Practice Alert) are available even if the expenses relate to a Midwestern disaster area.

Tax Relief for Businesses that are Victims of a Federally Declared Disaster The tax breaks for businesses affected by a federally declared disaster consist of bonus depreciation, a bigger expensing allowance under Code Sec. 179, expensing of qualified disaster expenses, and a longer NOL carryback.

Bonus depreciation for qualified disaster assistance property. For property placed in service after Dec. 31, 2007, with respect to disasters declared after that date, an additional depreciation deduction is allowed in the placed-in-service year equal to 50% of the adjusted basis of “qualified disaster assistance property.” (Code Sec. 168(n)) There is no AMT depreciation adjustment for qualified disaster assistance property recovered under Code Sec. 168(n). (Code Sec. 168(n)(2)(D))

Property is qualified disaster assistance property only if it meets all of the following requirements (Code Sec. 168(n)(2)):

(1) Qualifying type of property requirement. The property must be in one of two categories.

(a) Property described in Code Sec. 168(k)(2)(A)(i). This includes property to which Code Sec. 168 (which provides the MACRS rules) applies, and which has a recovery period of 20 years or less; computer software for which a deduction is allowable under Code Sec. 167(a), water utility property (which is a specialized class of MACRS property defined in Code Sec. Code Sec. 168(e)(5) and qualified leasehold improvement property (certain improvements to buildings made more than three years after the building is placed in service and that are made under a lease).

(b) Nonresidential real property or residential rental property (buildings and structural components of buildings).

(2) Active business use in a qualifying disaster area. Substantially all of the use of the property must be in a disaster area with respect to a federally declared disaster occurring before Jan. 1, 2010, and in the active conduct of a trade or business by the taxpayer in that disaster area.

(3) Rehabilitation or replacement of similar local property. The property must:

  • rehabilitate property damaged, or replace property destroyed or condemned, as a result of the federally declared disaster, except that, for purposes of this rule, property is treated as replacing property destroyed or condemned, if, as part of an integrated plan, the property replaces property that is included in a continuous area that included property destroyed or condemned; and
  • be similar in nature to, and located in the same county as, the property being rehabilitated or replaced.

(4) Original use requirement. The original use of the property in the disaster area must begin with an eligible taxpayer on or after the applicable disaster date (ADD). An eligible taxpayer is one who has suffered an economic loss attributable to a federally declared disaster. The ADD is the date on which a federally declared disaster occurs.

(5) Timely acquisition requirement. The property must be acquired by the taxpayer on or after the ADD by purchase (as defined in Code Sec. 179(d)(2) ), and no written binding contract for the acquisition can be in effect before the ADD. Rules similar to the specialized rules (e.g., for sale leasebacks) in Code Sec. 168(k)(2)(E)(i) and Code Sec. 168(k)(2)(E)(iv) apply.

(6) Placed-in-service requirement. The property must be placed in service by the eligible taxpayer by the end of the third calendar year (fourth calendar year for nonresidential real property and residential rental property) following the ADD. In other words, for example, for a 2008 federally declared disaster, the property may be put in service as late as Dec. 31, 2011 (Dec. 31, 2012 for nonresidential real property and residential rental property).

Ineligible property. Property is not treated as qualified disaster assistance property if (Code Sec. 168(n)(2)(B)):

(1) It is property to which the 50% bonus first year depreciation rules of Code Sec. 168(k) (determined without regard to Code Sec. 168(k)(4), relating to election to accelerate AMT and research credits instead of bonus depreciation) apply.

Observation: The 50% bonus first year depreciation rules of Code Sec. 168(k) generally apply for property acquired after 2007 and before 2009 (before 2010 for certain long-lived property). Thus, as a practical matter, for most businesses: (1) the 50% bonus first year depreciation rules of Code Sec. 168(k) apply for 2008 federally declared disaster areas; and (2) the 50% bonus first year depreciation rules for qualified disaster assistance property will apply only for federally declared disasters occurring in 2009.

Observation: There’s a move afoot in Congress to extend the 50% bonus first year depreciation rules of Code Sec. 168(k) for another year.

Observation: It’s generally better for a business to be governed by the bonus first year depreciation rules of Code Sec. 168(k) rather than the bonus first year depreciation rules for qualified disaster assistance property under Code Sec. 168(n), because the former subsection carries fewer restrictions than the latter.

Observation: Nonresidential real property and residential rental property (buildings and structural components of buildings) don’t qualify for bonus first year depreciation under Code Sec. 168(k) but may qualify for a bonus writeoff under Code Sec. 168(n).

(2) It is property to which the following applies: Code Sec. 168(l) (relating to 50% bonus first year depreciation for cellulosic biofuel plant property) or Code Sec. 168(m) (relating to 50% bonus first year depreciation for certain reuse and recycling property).

(3) It is property to which Code Sec. 1400N(d) applies (GO Zone property). (4) It is property to which Code Sec. 1400N(p)(3) applies. This is: (a) property used in connection with: a private or commercial golf course; massage parlor; hot tub or suntan facility; any store the principal business of which is the sale of alcoholic beverages for consumption off premises; or (b) gambling or animal racing property, including assets used directly in connection with these activities or their on-site viewing, and buildings or portions of buildings dedicated to these activities or their on-site viewing (unless the portion so dedicated is less than 100 square feet).

(5) It is property to which the alternative depreciation system (ADS) under Code Sec. 168(g) , without regard to Code Sec. 168(g)(7) (regarding the election to apply ADS), applies.

(6) It is property any portion of which is financed with the proceeds of any obligation the interest on which is exempt from tax under Code Sec. 103 .

Finally, qualified disaster assistance property doesn’t include any qualified revitalization building (certain nonresidential buildings located in areas designated as renewal communities) for which the taxpayer has elected the application of Code Sec. 1400I(a)(1) (an expensing deduction for 50% of qualified revitalization expenditures) or Code Sec. 1400I(a)(2) (amortization, over 120 months, of all qualified revitalization expenditures). (Code Sec. 168(n)(2)(B)(iv))

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