Olaf owns a 500-acre farm in Minnesota. A tornado hit the area and destroyed a f
ID: 2347544 • Letter: O
Question
Olaf owns a 500-acre farm in Minnesota. A tornado hit the area and destroyed a farm building and some farm equipment and damaged a barn. Fortunately for Olaf, the tornado occurred after he had harvested his corn corp. Applicable information is as follows:Item Adjusted Basis FMV before FMV after Insurance Proceeds
Building $90,000 $70,000 $0 $70,000
Equipment $40,000 $50,000 $0 $25,000
Barn $90,000 $120,000 $70,000 $25,000
Because of the extensive damage caused by the tornado, the President designated the area as a disaster area.
Olaf, who files a joint return with his wife, Anna, had $174,000 of taxable income last year. Their taxable income for the current year, excluding the loss from the tornado, is $250,000.
Determine the amount of Olaf and Anna
Explanation / Answer
The loss is a business loss. Therefore, for the farm building and the farm equipment that
were completely destroyed, the adjusted basis is used in calculating the amount of thecasualty loss. For the barn that was damaged, the lower of the adjusted basis
Building= ($90,000 – $70,000)=20 ,000
Equipment= ($40,000 – $25,000)=15000
Barn= ($50,000 – $25,000)=25000
Total loss=60,000
Because the President declared the area a disaster area, Olaf and Anna could claim the
loss on last year’s return or on the current year’s tax return.
If Olaf applies the loss to the prior year, the benefit of the loss will be at a tax rate of
27%. If the loss is applied to the current year, the benefit will be at a tax rate of 35%
rather than 27% and thus, provide a tax savings of $21,000 ($60,000 X 35%) rather than
$16,200 ($60,000 X 27%).
Olaf should include the loss on the current year’s tax return, since the tax savings is
$4,800 ($21,000 – $16,200) greater.
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