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Accelerating COVID-19 Related Disaster Losses Under §165(i)

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Background and Benefits

COVID-19 has had, and continues to have, devastating effects on the global health and economy. This has prompted many to seek tax relief to mitigate the losses that they have sustained either personally or to their business. While most attention has been focused on the CARES Act and Paycheck Protection Program (PPP), it is important to not overlook a pre-existing section of the Internal Revenue Code for additional relief – §165(i) Disaster Losses. Under §165(i), certain disaster losses sustained may “be taken into account for the taxable year immediately preceding the taxable year in which the disaster occurred.”

The primary benefit of §165(i) is to increase cash flow to those that have sustained a loss by reason of unexpected disaster. For those who have suffered a loss due to COVID-19, this could mean accelerating those losses from 2020 into 2019. By accelerating losses, current year tax liabilities may be reduced, therefore reducing any out of pocket expenses or potentially increasing the amount of tax refund available. In some instances, this may even increase a Net Operating Loss (NOL), which may be able to be carried back to prior profitable years due to provisions of the CARES Act.

Qualifications

This provision is triggered upon declaration by the President designating a disaster area to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. On March 13, 2020, President Donald J. Trump made such a declaration, which characterized the COVID-19 pandemic to be a national emergency and, therefore, activating the provisions of §165(i).

This provision is most traditionally utilized in the wake of natural disasters such as hurricanes, earthquakes or fires, which affect only specific geographic regions. In this instance, however, the relief under §165(i) will be available to all U.S. taxpayers, not limited to those in specific geographic regions.

Once §165(i) is triggered by declaration of the President, losses must satisfy a few general criteria under §165(a) in order to qualify. First, it is important to remember that §165(i) applies to property losses, rather than general losses resulting from business operations interruption. This represents another unique application to COVID-19 as there is likely to be less identifiable property damage than there would be after, for instance, a natural disaster. Additionally, losses must occur in closed and completed transactions, be fixed by identifiable events during the year, and sustained during the year of the event.

According to the declaration made by the President in March, the COVID-19 disaster officially began on January 20, 2020 and is continuing. This means that losses sustained to property that were a direct result of the COVID-19 pandemic beginning as early as January 20 may be eligible for deduction in the preceding year with a §165(i) election.

Documentation is an important component in making a valid §165(i) election as the burden of proof is on the taxpayer. The taxpayer must be able to show that losses were directly caused by the COVID-19 pandemic. Additionally, they should be able to substantiate the date the loss was sustained, that they were the owner of the property, or contractually liable to the owner for the damage, and whether a claim for reimbursement exists for which there is a reasonable expectation of recovery. All supporting documentation for the loss should be maintained and some, as explained below, may be required to be furnished along with the §165(i) election.

Examples

Examples of potential losses may include:

  • Store or facility closings
  • Scrapped inventory due to spoilage
  • Disposal of inventory, supplies and other property that is no longer sellable
  • Abandonment of leasehold improvements
  • Permanent retirement of fixed assets
  • Losses from the sale or exchange of property
  • Loss from worthless securities (not including bad debts)
  • Abandonment of capitalized business deals costs
  • Termination payments related to canceled contracts, leases or licenses
  • Capitalized expenses related to the prepayment when taxpayer is not provided a refund or credit (i.e. events, travel, hotel rooms, etc.)

It is important to remember that losses must be sustained to property in order to qualify. Therefore, the following are examples of losses that would not qualify for disaster loss treatment under §165(i).

  • Lost revenues
  • Decrease in fair market value of assets
  • Goodwill losses are generally not applicable under §165 (pending analysis of specific facts and circumstances)

Additional Considerations

Losses are only deductible to the extent that they are not compensated for by insurance or otherwise. Keep this in mind if there are outstanding insurance claims and a §165(i) election is being considered. If there is a reasonable prospect of recovery, the loss is not considered to be sustained.

An election under §165(i) applies to the entire loss resulting from the disaster during the disaster year. Therefore, COVID-19 related losses may either be deducted in 2020, the year of disaster, or in 2019, the year preceding the disaster, with a valid §165(i) election, not both.

Summary

Consider these rules as you decide if making a §165(i) election is right for you. Please consult your tax advisor for proper application to your unique set of facts and circumstances.

COVID-19 Business Resources

 

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

 

Disclaimer:  The contents of this resource are for general informational purposes only. While every effort has been made to ensure its accuracy, the information is provided “as is” and no representations are made that the content is error-free. We have no obligation to update any content, comments or other information for retroactive or prospective interpretations or guidance provided by regulators, financial institutions or others. The information is not intended to constitute legal advice or replace the advice of a qualified professional. There are areas of the CARES Act where additional clarification from the Treasury Department and the SBA is needed. Your judgment and interpretation of the act may be needed. Users should consult with their legal counsel and representatives of the lending institution regarding the proper completion of their application and supporting documentation.

 

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