Blake Christian, HCVT Tax Partner

January 10, 2025

Click here to download our Recommendations for Actions to Take After a Fire Loss.

The wildfires that have swept across Southern California have caused widespread devastation, leaving families, businesses, and communities in turmoil. As residents grapple with the aftermath, there is some relief available in the form of tax benefits through the federal and California casualty loss rules. These rules, both at the federal and state level, provide a critical financial lifeline for victims, enabling them to reduce their tax, access financial aid, and begin rebuilding their lives.

The January 2025 Wildfires: A Devastating Impact

California is no stranger to wildfires, with large swaths of the state regularly affected by fires during the dry summer months. However, these recent wildfires have been particularly severe, fueled by a combination of dry conditions, high winds, and record-high temperatures. These fires have destroyed tens of thousands of acres and thousands of homes and businesses, damaged critical infrastructure, and caused severe environmental harm. These fires continue to burn with a preliminary estimate of over $50 billion in damage.

As residents face these overwhelming losses of their properties, possessions, and livelihoods, understanding the potential tax relief available can be crucial in helping them recover financially.

Tax Filing and Payment Postponement

The Internal Revenue Service announced on January 10, 2025 tax relief for individuals and businesses in LA County affected by wildfires and straight-line winds that began on Jan. 7, 2025. These taxpayers now have until Oct. 15, 2025, to file various federal individual and business tax returns and make tax payments.

Taxpayers outside the disaster area, whose records are located in the affected area, are able to apply for postponement. We are continuing to monitor developments with respect to state conformity as well as to whether the postponement will impact additional California counties.

What Are Casualty Losses?

A "casualty loss" refers to property damage or economic loss caused by an unexpected, sudden, or unusual event, such as a fire, flood, or earthquake. Under the U.S. tax code, both federal and California tax law allows individuals and businesses to deduct certain types of losses resulting from such disasters.

In the case of the January 2025 wildfires, individuals and businesses affected by the fires may be eligible to claim a casualty loss deduction. This deduction can help reduce taxable income and thus provide financial relief by lowering the amount of taxes owed, or recovering taxes paid in prior years.

Federal Casualty Loss Rules

On Wednesday, January 8, 2025, President Biden signed a major disaster declaration for the wildfires impacting various communities in Los Angeles County. This will enable affected individuals and businesses to access individual program assistance from FEMA and other programs to cover expenses such as temporary accommodations and financial assistance for destroyed real and personal property.

The Internal Revenue Service (IRS) and California Franchise Tax Board (FTB) will issue additional guidelines that generally include extended tax filing deadlines, delays in making tax payments and possibly the option of claiming the 2025 casualty loss on either their 2024 or 2025 tax returns.

At the federal level, the IRS allows taxpayers to deduct losses related to casualty events like the California wildfires, provided specific criteria are met. Here is a current overview of the key federal rules regarding casualty losses:

1. Eligible Losses: Casualty losses must be caused by a sudden, unexpected, or unusual event, and the damage must be beyond normal wear and tear. This includes fire, flood, and other natural disasters.
   • In the case of the 2025 California wildfires, damage caused by the fires clearly qualifies as a casualty loss.
2. Determining Amount of Loss: Before deducting any casualty losses, a property’s value must be determined. For all personal-use property and business property not completely destroyed, the amount of your loss is determined by the lesser of the adjusted basis of your property or the decrease in fair market value (FMV) of your property as a result of the casualty (for businesses, including rental properties, that are destroyed, the amount of your loss is your adjusted basis minus any salvage value). To determine your deduction, you must determine your adjusted basis in the property before the casualty, determine the decrease in FMV due to the casualty, and subtract insurance or other reimbursements received now or in the future from the smaller of the two amounts.
   • For example, a personal-use property with an adjusted basis of $250,000 and a decrease in FMV of $1,000,000 will determine their loss using the smaller amount of $250,000. An insurance reimbursement of $50,000 (assume they only insured personal property) will result in a casualty loss of $200,000 ($250,000 - $50,000) before any deductions or limitations.
3. Calculation of the Loss: The IRS allows taxpayers to deduct the portion of their casualty losses that exceed $100 per event, per year. Additionally, the total loss must exceed 10% of the taxpayer’s adjusted gross income (AGI) to qualify for a deduction.
   • For example, if a taxpayer’s AGI is $500,000 and the casualty loss (after insurance proceeds) amounts to $300,000, the deductible amount would be $300,000 reduced by $100 (the $100 threshold) and further reduced by $50,000 (10% of their AGI). The $50,100 reduction to the $300,000 loss would result in a  net casualty loss deduction of $249,900.   This 10% limitation applies only to personal-use property and does not apply to business property or any portion of the home that is taken as a home office deduction. Therefore, business casualty loss deductions will always be higher.
4. Claiming the Deduction: With a Presidential Disaster designation, victims of the California wildfires can claim their casualty losses in the year the damage occurred, or they may generally choose to claim the loss in the previous tax year, allowing for a refund of taxes paid in that year. This flexibility specific to federally declared disasters is beneficial for victims who may be facing immediate financial challenges.
5. Insurance Proceeds: Casualty loss deductions are limited to amounts not compensated for by insurance proceeds. If the victim has insurance coverage for the losses, the amount of any insurance payout must be subtracted from the loss claim. If the insurance payout does not cover the entire loss, the taxpayer can still claim a deduction for the remainder of the loss. Due to many property insurers reducing their policy underwriting in California, some percentage of these fire victims were uninsured or under-insured and these casualty loss tax benefits will become even more critical. It is important to note that a timely insurance claim for reimbursement of loss must be made for it to be deducted as a casualty loss.
6. IRC Section 121, 1031 and 1033: These federal code sections may be available to fire victims to exclude (IRC Section 121) or defer (1031and 1033) any gain that may be realized from the disposition of their residential or business properties. In the case of a sale or non-replacement of a personal residence, the taxpayer can claim a $250,000 (Single or Married Filing Separate) or $500,000 (Married Filing Joint). In the event the sales proceeds and/or insurance proceeds received by the property owner exceed the tax basis of the victim’s property, the taxpayer can find a replacement property and invest those proceeds into new property. The 1031 rules have a very short identification (45 days) and replacement period (180 days), while the 1033 rules applicable to Involuntary Conversions allow up to two years from the end of the year that the taxpayer first received proceeds.

Example Tina’s house is destroyed by fire on January 7, 2025. The house had an adjusted basis of $350,000. Prior to the fire, Tina had lived in and used the house as her principal residence for 20 years. Tina’s insurance company pays her $1,000,000 for the house during 2025. Tina realizes a gain of $650,000 for the house ($1,000,000 - $350,000). On November 15, 2027, she pays $300,000 for a new house in another state. For the purposes of IRC §121, the destruction of the house is treated as a sale. Tina can exclude $250,000 of the realized gain from her gross income (principal residence exclusion), leaving her with $400,000 in potential tax gain ($650,000-$250,000). For purposes of IRC §1033, the amount realized is $750,000 ($1,000,000 – $250,000 (Section 121 exclusion) and the remaining tax gain realized is $400,000 ($750,000- $350,000 adj basis).  Since she reinvested $300,000 in a replacement property, only $100,000 ($400,000-$300,000) would remain taxable- but at a favorable capital gain classification.

California Casualty Loss Rules

California offers similar tax relief for wildfire victims, in addition to the federal provisions. The California Franchise Tax Board (FTB) follows federal rules on casualty losses in many respects but has some distinct nuances:

1. California’s Approach: In California, casualty loss deductions are handled through the state income tax system, similar to the federal system. Taxpayers can deduct the portion of their loss that exceeds a set threshold and impacts their overall income.
2. State-Specific Rules: Unlike the federal tax rules, California does not have a standard $100 threshold for each casualty event. Instead, California requires that the taxpayer’s loss exceed 10% of their adjusted gross income before it can be deducted.
3. No Limit on Carrybacks: While the IRS allows taxpayers to carry their casualty loss claims back to previous tax years, California follows a more limited approach. This means that those affected by the January 2025 wildfires can apply their casualty losses against future years’ taxes, but retroactive claims may be more restricted than at the federal level. We will need to wait for guidance from Sacramento and the FTB to determine whether California will allow taxpayers to claim the loss in 2024 or allow a carryback of a loss incurred in 2025.  Last year California limited individual and business taxpayers from utilizing Net Operating Losses for 2024 and 2025.
4. Special Disaster Provisions: Be alert to potential modifications to the current provisions as California often enacts special tax relief measures in response to major disasters, such as wildfires. These measures can include more generous deductions, suspension of certain filing deadlines, and other forms of assistance to help victims recover. California may provide additional aid in the wake of the 2025 wildfires, including allowing taxpayers to deduct losses that otherwise might not be allowed under normal circumstances.

How to Claim Your Income Tax Deductions

To claim a casualty loss on your federal and California state tax returns, you will need to complete the following federal and California state specific forms:

• Federal Tax Forms:
  • Form 4684: Casualties and Thefts – This form is used to calculate and report casualty and theft losses.
  • Schedule A (Form 1040): Itemized Deductions – Report the deductible amount from Form 4684 on line 15.
• California State Tax Forms:
  • Form 4684: California conforms to federal Form 4684 for reporting casualty and theft losses.
  • Schedule CA (Form 540): California Adjustments – Reflect any differences between federal and state deductions here.
  • Form FTB 3805V: Net Operating Loss (NOL) Computation and NOL and Disaster Loss Limitations – Individuals, Estates, and Trusts – If applicable, use this form to compute any net operating loss related to your casualty loss.

For detailed guidance on claiming a disaster loss in California, refer to the IRS Publication No. 515 and the California Franchise Tax Board’s Publication 1034.

Los Angeles County Property Tax Relief

Since your property has decreased in value, you can request a property tax reassessment, or Misfortune and Calamity (M&C) relief, and reduce your property taxes for 2025 or even refund property taxes that may have been prepaid. In order to qualify, the estimated property damage must be at least $10,000 in market value and claims must be filed with the county assessor within the specified time or within 12 months from the date of damage, whichever is later. Additionally, if you file a property tax deferral claim with the county assessor before the next property tax installment payment date, that payment will be postponed without penalty or interest until the county assessor has reassessed the property and you receive a corrected tax bill.

Property tax reassessment is available for real property, business equipment, fixtures, orchards, aircraft, boats, and certain manufactured homes. It is not available to property that is not assessable, such as state licensed manufactured homes or household furnishings.

Use this form to apply for M&C relief:  https://assessor.lacounty.gov/tax-relief/disaster-relief

Key Steps for Fire Victims to Maximize Their Tax Relief

1. Document Losses: Proper documentation is essential for claiming a casualty loss deduction. Fire victims should keep detailed records of the damage, including photographs, written descriptions, and any repair or replacement costs. If possible, victims should also keep receipts and statements from their insurance companies.  There are also companies that can assist fire victims with documenting their losses.
2. File a Timely Claim: Victims should file their casualty loss claims as part of their annual tax return. If they missed the tax filing deadline, the IRS and California’s FTB provide provisions for late filing and special disaster-related extensions. It is also important to stay updated on any additional emergency extensions or programs that may be introduced in response to the 2025 wildfires.
3. Consult a Tax Professional: The rules surrounding casualty loss deductions can be complex, and the financial situation for wildfire victims may vary widely. Seeking guidance from a tax professional who understands both federal and California tax laws can ensure that victims claim all possible benefits and navigate any special tax relief measures available.
4. Consider Other Relief Options: Victims may be eligible for other forms of financial assistance, such as disaster relief grants, low-interest loans, and emergency funding. While these programs are not directly related to taxes, they can complement the tax benefits and provide additional relief for those struggling to rebuild.

Conclusion

The 2025 California wildfires have caused unprecedented destruction, but the federal and state tax systems provide crucial support for victims through casualty loss deductions. Both the IRS and California’s FTB offer tax relief measures that can reduce the financial burden on those affected, enabling them to start rebuilding their homes, businesses, and lives.

By understanding the rules and seeking professional guidance, wildfire victims can take full advantage of the tax benefits available, helping them recover and regain their financial footing in the wake of this devastating disaster.

Disaster Resources

Click here to download our Recommendations for Actions to Take After a Fire Loss.

Additional Resources can be found at:

• Greater Los Angeles Current Wildfire Information | 211LA
• Winter Winds & Wildfires | Emergency Management Department
• Disaster loss deduction | FTB.ca.gov
• The Department of Forestry and Fire Protection | CAL FIRE
• Resources for SoCal Fire Victims, Evacuees and First Responders

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Blake Christian is a Tax Partner in the Long Beach and Salt Lake City offices of HCVT – the largest firm based in Southern California.  Mary Ceja is a Tax Staff in the Phoenix office of HCVT.  For more information please check their website at: www.hcvt.com