The widespread devastation left in the wake of hurricanes has resulted in numerous tax provisions aimed at revitalizing and rebuilding the affected areas. Congress passed the Gulf Opportunity Zone Act of 2005, P.L. 109-135 (the GO Zone Act), in response to Hurricane Katrina and then revised it as Hurricanes Rita and Wilma wreaked havoc on the already battered Gulf Coast. Two years after its passage, the GO Zone Act is still relevant, notably the provisions relating to business property and issues such as involuntary conversion rules, nonrecognition of gain principles, and depreciation.
One of the most significant changes to current tax laws is in the area of involuntary conversions. Congress in-creased the time to acquire or construct replacement property from two to five years for anyone located within the Hurricane Katrina disaster area (Katrina Emergency Tax Relief Act of 2005, P.L. 109-73, Section 405). The five-year period begins from the date a taxpayer first receives insurance proceeds, not when the full amount is received. Should a taxpayer need additional time—for example, if the receipt of all proceeds is crucial to purchasing replacement property—he or she may file an application for extension with the IRS with an explanation as to why additional time is needed. A taxpayer may acquire replacement property anywhere within the Hurricane Katrina disaster area. It is not limited to the same location where the damage occurred in order to avoid gain recognition on the conversion. For a complete listing of counties and parishes located in the Katrina, Rita, and Wilma GO Zones, see IRS Publication 4492, Information for Taxpayers Affected by Hurricanes Katrina, Rita, and Wilma.
As with any property that has been involuntarily converted, the taxpayer does not have to recognize a gain if the proceeds are used to purchase qualified replacement property. This provision encompasses both partially and completely destroyed property. Special consideration should be given to having adequate records of the items destroyed. The IRS has allowed separate property to be treated differently when applying the nonrecognition rules. This may be helpful when determining if any gain or loss should be recognized on the property. Involuntary conversion and nonrecognition of gain rules generally apply to qualified GO Zone property, with a few notable exceptions. First, if an uncompensated Sec. 1231 loss occurs, Congress has allowed the loss to be eligible for a five-year carryback period (Sec. 1400N(k)). The taxpayer must be able to establish that the property meets the requirements of Sec. 165, and the involuntary conversion must be a result of Hurricane Katrina. Second, a taxpayer is allowed to purchase any tangible business property in order to avoid recognizing gain. Under normal circumstances, a taxpayer would be required to purchase similar or related property.
Not only can a taxpayer avoid having to recognize a gain on the property, but additional incentives exist for placing new property into service in the GO Zone. First, Congress allowed an extension of the 50% bonus depreciation on qualified property placed in service in a GO Zone (Sec. 168(k)). To qualify, property must have been acquired on or after August 28, 2005, and placed in service before January 1, 2008; for nonresidential real property and residential rental property, the placed-in-service deadline is extended to January 1, 2009 (Sec. 1400N(d)(2)
(A)(v)). It is important to note that if a contract was entered into before August 28, 2005, the property will not qualify. Although specific dates are not listed in all subsections of the GO Zone Act, a general guideline would be to replace August 28, 2005, with September 23, 2005, for the Rita GO Zone and October 23, 2005, for the Wilma GO Zone.
As always, there are exceptions to these rules:
There is an extension of time until January 1, 2011, for nonresidential real property and residential rental property that is placed in service in specific areas of the GO Zone (Sec. 1400N(d)(6)). These are areas where the 2005 hurricanes damaged more than 60% of the occupied housing.
Sec. 1400N(f) allows the taxpayer to elect to expense 50% of qualified GO Zone cleanup costs, which are expenses paid for the demolition of structures or debris removal for the period August 28, 2005–December 31, 2007.
The GO Zone Act increased the expensing allowed under Sec. 179 for qualified GO Zone property placed in service on or after August 28, 2005, and before January 1, 2008. The dollar amount in effect under Sec. 179(b)(1) is increased by either the lesser of $100,000 or the cost of the Sec. 179 GO Zone property placed in service; under Sec. 179(b)(2), the limitation is either the lesser of $600,000 or cost. Taxpayers may amend their returns to elect Sec. 179 treatment without consent of the commissioner in the tax years be-ginning after 2002 and before 2008.
In addition to federal exceptions, state exceptions may also apply because each state applies federal provisions differently. The practitioner should check for GO Zone Act conformity by states outside of the GO Zone. Within the GO Zone, Alabama, Louisiana, and Mississippi differ in provisions to which they conform. None of the states recognizes the federal change in the NOL carryback period in the Hurricane Katrina disaster area. Mississippi does not adopt the 50% bonus depreciation provision, but Alabama and Louisiana both follow federal tax treatment. Alabama, Louisiana, and Mississippi adopted the election to deduct 50% of the cleanup and demolition costs for state purposes. In addition, the individual states may have specific relief or incentive provisions that are not tied to federal rules. Louisiana, for example, may allow additions to the federal in-come tax deduction for federal taxes that were reduced by specific tax credits related to the disasters.
The GO Zone Act provided several tax provisions for business property that are still of note today, including those related to involuntary conversions, nonrecognition of gain, and increased depreciation. Each of these items should be monitored because they may have significant effects on taxpayers, especially those doing business within the GO Zone. Now is the time to be aware of them, because many of the provisions expire at the end of the 2007 tax year.