Robert W. Wood
Managing Partner
Wood LLP
333 Sacramento St
San Francisco , California 94111-3601
Phone: (415) 834-0113
Fax: (415) 789-4540
Email: wood@WoodLLP.com
Univ of Chicago Law School
Wood is a tax lawyer at Wood LLP, and often advises lawyers and litigants about tax issues.
If your home or property is destroyed or damaged in a
wildfire, you are likely to have surprisingly complex tax issues. If you
recover money from insurance or a lawsuit--or if you just claim a casualty loss
on your taxes, you need to be aware of some tax rules. Several key tax issues
and benefits hinge on whether your fire was a "federally declared disaster" for
tax purposes.
Casualty loss deductions and more
Claiming a casualty loss on your taxes after a disaster can
help you keep funds you would otherwise have to pay in taxes. Casualty loss
deductions are limited to the lesser of your adjusted tax basis in your damaged
property, and the reduction in the fair market value of the property from the
disaster. So even if you lost a very expensive home with a high fair market
value, if you paid a small amount for it many years ago, your basis--and
therefore your tax deduction--is small.
Since 2018, you can generally claim this deduction only if
your loss was in a federally declared disaster. This limitation is set to
expire at the end of 2025, but the One Big Beautiful Bill Act in Congress would
make this rule permanent. You can claim a casualty loss deduction in the tax
year immediately before the year of the disaster. Thus, LA fire victims who
lost homes in January 2025 can claim a casualty loss on their 2024 taxes, even
though the loss did not occur during 2024. Claiming a casualty loss is a
popular tax break for fire victims in disaster areas, but it can have downsides
if you later receive insurance or lawsuit proceeds.
Involuntary conversions
Section 1033 of the tax code is a key relief provision for
victims of disasters. Generally, amounts received for damage to property,
including property insurance payments, are treated as sales proceeds for tax
purposes. Whether you have a gain is based on your tax basis in the property.
Section 1033 generally allows property owners to elect to defer
paying tax on their casualty gain. Making the election allows you to
reinvest insurance or litigation proceeds into the repair, reconstruction, or
replacement of your damaged property within prescribed time limits. The time to
reinvest can be tricky and depends heavily on your facts. Indeed, it is
possible that the Section 1033 replacement period may have already ended
(because of your previous receipt of insurance payments) when a litigation recovery
for the fire is eventually paid. The timing is tricky, but if you can meet the
timing, the property owner does not have to pay immediate tax on the casualty
gain, and the gain can be deferred indefinitely until the property is later
sold. The net effect of these rules is that a fire victim often can avoid owing
any income tax on their insurance proceeds until the property is later
sold.
Section 1033 in federal disaster areas
1. The rules that apply under Section 1033 depend on
whether the involuntary conversion occurred during a federally declared
disaster. If it did, you may be eligible for the following benefits: Exclude
from your income most insurance proceeds received for personal property damaged
or destroyed in the disaster if that property was located at your primary residence;
2. Treat all other insurance proceeds for damage to your
primary residence as a single asset to get the full benefit of your adjusted
tax bases in all the affected property before any casualty gain is produced;
3. Treat the acquisition of any replacement property
related to your principal residence as qualifying replacement property for any
other property located at your principal residence;
4. Double the replacement period for damaged property under
a Section 1033 election from two years to four years; and
5. Treat the acquisition of any tangible property to be
held for productive use in a trade or business as qualifying replacement
property for any other damaged property that was held for productive use in a
trade or business or held for investment.
If you have casualty gain from a federally declared
wildfire that damaged your principal residence for the first time in a
given tax year, you have until four years from Dec. 31 of that year to reinvest
the proceeds under Section 1033. Despite these more liberal tax rules, there
can still be timing issues for non-principal residences, and more generally. Any
casualty gain you have in any subsequent tax year must be reinvested by the
same deadline, which was based on the first year you had a casualty gain. Therefore,
some casualty gain may have less than four years to be reinvested under
Section 1033, if the casualty gain was first triggered in a previous tax
year.
While Section 1033 isn't the only relevant tax
provision for fire victims, it is typically the primary way they can rebuild
without immediate tax liability when recovery payments result in a casualty
gain.
Tax exclusion for 2020 - 2025
In December 2024, Congress enacted the Federal Disaster Tax
Relief Act of 2023, providing an exclusion in the tax law so that many wildfire settlements are tax-free
if received during the years 2020 through 2025. The exclusion does not
apply to all fire victims or all fires--it applies only to fires that
were federally declared disasters. For wildfires that are not federally
declared disasters, you must rely on Section 1033 and other provisions.
The new law applies only to payments to individuals,
so partnerships, irrevocable trusts, and various other entities appear not to
qualify. The only major carve-out of the exclusion is that an amount cannot be
excluded if it compensates the taxpayer for a loss or expense that has
already been reimbursed by another source, e.g., through insurance.
What are federally declared disasters?
All these tax provisions use the "federally declared disaster"
term and cite Section 165(i)(5) of the tax code. Section 165(i)(5) defines a
federally declared disaster as "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,"
commonly known as the Stafford Act. The Stafford Act appears to have three
principal types of disaster relief declarations for wildfires:
1. Emergency Declarations under Section 501 of the Stafford
Act,
2. Major Disaster Declarations under Section 401 of the Stafford
Act, and
3. Fire Management Assistance Declarations under Section 420 of
the Stafford Act.
Emergency Declarations are for emergencies where immediate
federal assistance is needed and the normal formalities for declaring a Major
Disaster would take too long. The FEMA website suggests disasters that receive
Emergency Declarations under Section 501 of the Stafford Act are often assigned
numbers with the prefix "EM," presumably for "emergency." Similarly, all
disaster declarations under the Stafford Act also appear to include a suffix
indicating which state requested federal assistance. Therefore, all disaster
declarations for California wildfires appear to end with "CA."
Emergency Declarations are less common for wildfires, perhaps
because there is a separate avenue for emergency federal assistance with
wildfires, the Fire Management Assistance Declarations under Section 420 of the
Stafford Act. Indeed, only two wildfires appear to have been issued Emergency
Declarations since 2019: the 2020 Oregon Wildfires (designated 3542 | FEMA.gov) and the 2021
California Caldor Fire (designated 3571
| FEMA.gov,). Sometimes, the EM designation is listed after the declaration
number, e.g., 3571-EM-CA instead of EM-3571-CA, but this does not
appear to indicate any substantive distinction, and sometimes the ordering
appears to change from one web page or document to another for the same
disaster.
Major Disaster Declarations under Section 401 of the Stafford
Act have the prefix "DR" on the FEMA website. Major Disaster Declarations under
the Stafford Act qualify victims for the widest scope of direct federal
assistance through FEMA. If a fire victim checks to see if they qualify for direct
federal assistance from the official US government website, the application
deadlines for direct federal relief are typically all disasters with Major
Disaster Declarations under Section 401. See, "Home | disasterassistance.gov."
Some wildfires were issued Major Disaster Declarations,
including the 2015 California Butte Fires (4240 | FEMA.gov), the 2017
North Bay Fires (4344 | FEMA.gov),
and 2018 Woolsey Fire and Camp Fire (4407 | FEMA.gov). Any wildfire
with a Major Disaster Declaration or an Emergency Declaration clearly qualifies
as a federally declared disaster for tax purposes. Section 1.165-11(b)(1) of
the Treasury Regulations states that a federally declared disaster for tax
purposes "includes both a major disaster declared under Section 401 of the
Stafford Act and an emergency declared under section 501 of the Stafford Act." Therefore, these two types of declarations
are specifically identified as being included within the definition of a
federally declared disaster for tax purposes.
Fire management assistance declarations?
How about the third category? Section 1.165-11(b)(1) is silent
about Fire Management Assistance Declarations, the third major type of
declaration for wildfires under the Stafford Act. The statutory language
suggests that a federally declared disaster refers to any disaster that has
received a declaration by (or by a delegation of) the President asserting that
it qualifies for federal assistance under the Stafford Act. Plainly, Section
420's Fire Management Assistance Declarations (and the relief they authorize)
are a form of federal assistance authorized under the text of Section 420 to be
provided or authorized by "The President" (although usually delegated in
practice to a FEMA Regional Administrator).
Fire Management Assistance Declarations usually do not provide
or authorize the same scope of direct federal assistance to wildfire
victims as Major Disaster Declarations. Instead, Fire Management Assistance
Declarations authorize FEMA to provide grant money, equipment, supplies, and
personnel to State or local governments to help the State and local governments
more effectively deal with the containment of and recovery from wildfires. See
Stafford Act § 420, 42 U.S.C. 5187. Perhaps because Fire Management Assistance
Declarations do not provide direct federal assistance to the individual
wildfire victims, for non-tax purposes they are often treated as if they
are not federally declared disasters, or as if they do not provide federal
assistance to wildfire victims.
Because federal assistance is being provided to the State and
local government, the individual victim's point of contact to receive disaster
relief may remain the State or local government, even if the relief appearing
to be provided by the State or local government is being provided by the
federal government under the Fire Management Assistance Declaration. However,
Section 165(i)(5) of the tax code does not contain text that suggests it is
required that a federally declared disaster provide direct assistance by
the federal government to victims. It only requires that the disaster be
determined by the President to "warrant assistance by the Federal Government"
under the Stafford Act.
In a 2019 published Program Manager Technical Advice memo, the
IRS Office of Chief Counsel concluded that for the purposes of qualifying as a
federally declared disaster, the assistance granted under the Stafford Act
could include "Individual Assistance and/or Public Assistance." PMTA 2019-08 (Jun. 28, 2019). The term
"Public Assistance" is generally used to describe the kind of indirect federal
assistance through State or local governments authorized under provisions of
the Stafford Act, including as a result of Fire
Management Assistance Declarations. See, e.g., Congressional Research
Service, "A
Brief Overview of FEMA's Public Assistance Program | Congress.gov | Library of
Congress" (Feb. 28, 2024), ("[Public Assistance] is only
available after the President declares an emergency or major disaster or FEMA
authorizes a Fire Management Assistant [sic] Grant (FMAG) under the
Stafford Act.").
The provision of money, equipment, supplies, and FEMA personnel
to a State or local government to assist in wildfire containment and recovery
efforts appears, under its plain meaning, to squarely fall within the
definition of "assistance by the Federal Government" under the Stafford Act. Indirect
assistance may also be provided to State and local governments as a result of an Emergency Declaration or Major Disaster
Declaration. Although the term "federally declared disaster" by its plain
meaning seems to most directly suggest the Major Disaster Declaration under
Section 401 of the Stafford Act, the fact that Emergency Declarations are also
specifically included within the definition of federally declared disaster
under Treasury Regulations suggests that the term federally declared disaster
should not be limited to Major Disaster Declarations, notwithstanding the
superficial similarities in terminology.
Many recent major wildfires received disaster declarations under
Section 420's Fire Management Assistance provisions. The LA fires in 2025,
including in Pacific Palisades, were not originally granted Major Disaster
Declarations, but were originally granted Fire Management Assistance
Declarations. This is clear from the prefix "FM" to the FEMA disaster
declaration numbers (i.e., FM-5549-CA (Palisades Fire), FM-5550-CA
(Eaton Fire), FM-5551-CA (Hurst Fire)), and by the text of the notices
announcing the disaster declarations.
However, on the day after they were granted relief under
the Fire Management Assistance provisions of Section 420, they were also the
subject of a Major Disaster Declaration under Section 401. See 4856 | FEMA.gov. This
supplemental disaster declaration is important for victims for non-tax reasons
because it opened up more avenues for direct federal
assistance. But it is not clear that the Major Disaster Declaration was
required for federal tax purposes if the three Fire Management
Assistance Declarations were already sufficient to qualify the fires as
federally declared disasters. For at least one recent wildfire, the 2021 Caldor
Fire, FEMA felt it was necessary for providing the full scope of federal relief
deemed needed for that fire to issue disaster declarations under all three
provisions of the Stafford Act used to declare wildfire disasters, a Major
Disaster Declaration (DR-4619-CA), an Emergency Declaration (EM-3571-CA), and
a Fire Management Assistance Declaration (FM-5413-CA).
Nevertheless, most wildfires remain disasters declared only under
Section 420's Fire Management Assistance relief provisions without a Major
Disaster Declaration under Section 401 or an Emergency Declaration under
Section 501. See, e.g., the 2019 California Kincade Fire (5295 | FEMA.gov). In fact,
between 2018 and 2025, 356 fires nationwide received Fire Management Assistance
Declarations, but only 28 received Major Disaster Declarations. We are not
aware of any cases or IRS guidance suggesting that only the 28 wildfires with
Major Disaster Declarations are federally declared disasters within the meaning
of Section 165(i)(5) of the tax code. They still appear to fall within the
statutory definition.
More practically, they are still identified as disasters, with
assigned declaration numbers on the FEMA website. Similarly to Emergency
Declarations and Major Disaster Declarations, Fire Management Assistance
Declarations appear on the FEMA website under the heading "All Disaster
Declarations," and the declaration information page for any Fire Management
Assistance Declaration includes sub-headings for "How a Disaster Gets
Declared," "Disaster Authorities," "Historic Disasters," "Disaster Recovery
Centers," and "More About This Disaster."
Fire Management Assistance relief under Section 420 of the
Stafford Act appears to often be granted for wildfires for the same purpose
that an Emergency Declaration might be used outside of the wildfire context. There
have only been four wildfires nationwide that have been issued Emergency
Declarations since 2018, compared to the 356 fires that received a Fire
Management Assistance Declaration.
During the same period, the FEMA website's search function
produces Emergency Declarations under Section 501 of the Stafford Act for at
least 23 disasters involving flooding, 61 disasters involving hurricanes, and
10 disasters involving tornadoes. This suggests that a principal reason,
perhaps the principal reason, there have only been four wildfires issued
Emergency Declarations in the same period may be because substantially the same
federal emergency assistance normally provided through Emergency Declarations
for other types of disasters is being provided for wildfires through the Fire
Management Assistance Declarations.
There are differences between the two types of declarations, of
course. See, e.g., FEMA, "Wildfires
and Declarations: An Overview" (v. Apr. 2024. However,
both are usually granted to provide federal assistance to state and local governments
to help contain emerging disasters. The regulations under Section 165 of the
tax code suggest that Emergency Declarations under Section 501 of the Stafford
Act are considered federally declared disasters for tax purposes, regardless of
whether they later result in a Major Disaster Declaration. It would be unusual
if similar federal assistance usually provided in the wildfire context, and also under a provision of the Stafford Act, would not be
treated similarly as an Emergency Declaration for income tax purposes.
State-declared
disasters
Some devastating wildfires are not designated as disasters by
FEMA under any provisions of the Stafford Act. For example, the Mountain
View Fire of 2020 burned for nearly a month, consuming nearly 21,000 acres in
California, destroying 80 buildings (damaging many more), and killing at least
one person. Nevertheless, this fire was not large enough for FEMA to consider
it outside of the combined capability of the California state and local
governments and relief organizations to address without federal involvement. Therefore,
the Mountain View Fire was designated by California as a state disaster,
but not a federal disaster by FEMA.
A
disaster declaration by a state is NOT sufficient to qualify a disaster as a
federally declared disaster for federal tax purposes. Section 165(i)(5) clearly
requires a federal designation under the Stafford Act, a federal law. It
is easy to get confused, but no state-declared disaster that is not federally
declared has a disaster description and designation on the FEMA website. For
example, there is no FEMA disaster declaration page for the 2020
Mountain View Fire under the EM, DR, or FM prefixes.
For
state-declared disasters that are not federally declared disasters, the main federal
recognition of the disaster is not by FEMA. Instead, the recognition (if
any) is usually by the US Small Business Administration (the SBA). The Small
Business Act authorizes the SBA to facilitate loans to victims in the aftermath
of disasters, and the relevant definition for disaster under the Small Business
Act's disaster loan assistance program is broader than just federally
declared disasters; it can include state-declared disasters. P.L. 85-536, as
amended, 15 U.S.C. 631 et seq.
Therefore,
in the context of state-declared disasters, the SBA may issue a notice in the
Federal Register acknowledging that a state-declared disaster qualifies for
loan assistance under the Small Business Act. See, e.g., "Federal
Register: Administrative Declaration of a Disaster for the State of California." These SBA notices also assign
a disaster number to the disasters that qualify for disaster loan assistance
under the Small Business Act, presumably to help with the administration of the
disaster loan assistance program.
The
disaster numbers assigned to state-declared disasters by the SBA for the
purposes of the disaster loan assistance program under the Small Business Act
do not correspond to the formatting of FEMA disaster declarations, but most
wildfire victims likely may not notice such an arcane clue that the SBA notices
are related to an entirely different statutory regime. It can be confusing for
wildfire victims if, in their internet research, they come across an SBA notice
in the Federal Register regarding a wildfire. The fact that it is a federal
agency assigning a disaster number to the wildfire in the Federal Register as
part of an announcement that relief under a federal law is available to victims
can easily make it seem like the disaster being described must be a
federally declared disaster.
However,
for federal income tax purposes, a federally declared disaster must be a
disaster declared under a provision of the Stafford Act, which is nominally
done by the President, though nearly always in practice by delegation to FEMA. Unfortunately
for the victims of the wildfires that fall into the category of state-declared
disasters, an SBA notice applying the disaster loan assistance provisions under
the Small Business Act is not sufficient to make a state-declared disaster a
federally declared disaster for income tax purposes.