Over the coming weeks, Congress will write tax and expenditure laws that include taxes and relief for many victims of the Eton fire. But apart from the cash assistance already requested by Gov. Gavin Newsom, California’s legislative delegations should work to include two urgently necessary changes to tax laws in the same law. Without these, it could take years to rebuild a region with severe fires in Los Angeles.
The Internal Revenue Code is not written with large urban wildfires in mind. By taxing income from income as income, current tax laws encourage many fire victims to keep their now vacant lots until they die to avoid the vast tax bill. The tax law also discourages potential buyers from purchasing empty lots and building new homes. These perverse incentives dramatically slow the restructuring process. The way to fix this is to change the way tax laws apply in disaster areas where the president has been declared.
The California delegation in Washington should find a receptive audience in Congress for this individual reform. It is essential to restore the tax base for both state and federal income.
For the first reform, Congress should exempt victims who declared fire disaster areas declared president from income taxes resulting from receipt of insurance income and the sale of their lots.
Second, to encourage buyers in fire areas, councils must allow income tax deferrals on the sale of major residences if sales revenue is used to purchase or build new major residences for firefighters.
In Palisades in the Pacific, where property values have skyrocketed over the past decades, many homeowners owned their assets for over 20 years at the time of the fire. Even before the disaster occurred, these inhabitants (many of them older people) had a strong incentive to hold their property until the death. In doing so they could forever avoid the income tax on their home appreciation.
The incentive remains after the fire. But now that people have been kicked out of their homes, the effect has changed dramatically. Previously, people staying in their homes did not present any special issues to them or their community. Now people evacuate burnt-out lots, but keep holding them in that state until they die, causing great problems. This is the worst outcome for the community. The former residents are not rebuilt or return, and new residents are not given the opportunity to build and move.
The tax bills faced if the fire department bill sold are something that they might have had to pay for the disaster. And it is not just a product of gratitude for their wealth over time. Insurance makes your photography even more complicated.
Under current law, property insurance revenues reinvested in a new home are generally tax-free, but incomes that are not reinvested are subject to tax. Therefore, fire victims who sell burned homes and shrink or move to cheaper areas will face double tax whammy.
Older couples whose children have moved in for a long time probably aren’t interested in rebuilding. For them, sales and downsizing have the most practical meaning. But not after taxes are considered. If they receive big payments from homeowners’ insurance, but don’t dedicate all of that to a new home and sell their original assets for a large sum, they could face an astonishing income tax bill. For many, this feels like an insult, and comes right after being kicked out of their homes and seeing almost everything they once owned rise in smoke.
Unfortunately, the easiest way for fire victims to avoid this financial hardship is to keep the blackened lot until they die while traveling to buy elsewhere. As long as 100% of your insurance makes money into your new home elsewhere, you can avoid these taxes entirely. At the same time, they can borrow to generate tax-free cash, contrary to the value of their lot. These funds can be used to supplement the costs of small homes and help you pay for living expenses. It’s probably great for them, but bad for Southern California and its tax base.
The other parts of the tax law addressed are about firefighter buyers. For decades, tax rules have been that buyers who purchase new major residences at a higher amount than the selling price of their previous residences could postpone income tax from their moves. However, since 1997, the profits of that provision have been limited to $250,000 ($500,000 if you are married). Inflation further reduced its value. $250,000 in 1997 is equivalent to just $125,000 today. Restoring the rules of the buyer’s fire department before 1997 ensures that there are buyers and sellers. It stimulates the market for reinvestment of these crushed communities.
These two reforms correspond to simple justice. Fire victims should not suffer from income taxes that would otherwise not be paid. Tax law should not encourage people to retain burned lots for the rest of their lives at the expense of the surrounding community. Introducing appropriate tax incentives for both buyers and sellers will lead to faster and better construction of Palisades in Altadena, Malibu and the Pacific. And this regenerates tax revenues for the benefit of Californians and all American taxpayers.
Christopher Cox is a senior resident scholar at UC Irvine and is the former chairman of the U.S. House of Representatives’ Committee on Homeland Security. Hank Adler is a professor of accounting at Chapman University.
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