With weather-related disasters on the rise, many home and business owners across the U.S. have experienced substantial and unexpected losses that may entitle them to the casualty loss deduction or other IRS-related relief. In advance of a natural disaster striking your home or business, you should be aware of what makes you eligible to receive a federal casualty loss tax deduction, how insurance reimbursements can impact the deduction, what the loss amounts in comparison to the deduction amounts allowed are, and the critical role that keeping good records plays in the process.
What Constitutes a Casualty Loss Deduction?
While the normal deterioration that happens to property over time doesn’t make you eligible to claim a federal casualty loss tax deduction, damage and losses that result from unexpected weather-related disasters such as hurricanes, tornadoes, earthquakes, floods, and fires, could afford you the opportunity to claim the deduction.
However, the rules surrounding eligibility vary widely for homeowners and business owners. Typically, homeowners may be able to claim the casualty loss deduction for damage done to both the home itself or the items inside it, if the damage resulted from a federally declared disaster. Damaged vehicles designated for your personal use that you have parked on your impacted property also qualify. If the President of the United States has sanctioned a specific disaster area eligible to receive federal assistance, the owner of the structure and its items will likely be able to receive that assistance and claim the casualty loss deduction.
Broader guidelines apply to business owners or owners of income-producing property such as rental property in that a federal disaster declaration is not necessary for the deduction to be claimed.
Casualty losses are deductible in the year of the loss which usually correlates with the year in which the disaster event occurred. If the losses can be directly tied to the federally declared disaster, you have the flexibility to treat those losses as if they’d happened in the prior year. This may prove an efficient way for you to receive a refund more quickly but you will have to amend your prior year’s return in order to get the wheels turning on the refund process.
Accounting for Insurance Reimbursements and Their Potential Tax Liability
For some, casualty losses may be covered by insurance. If you have losses due to a disaster which are, in fact, covered by insurance, you are required to reduce the total cost of your losses by the amount of the insurance reimbursement (or expected reimbursement) you receive. Additionally, you must reduce the loss by any salvage value, associated.
It’s important to note that insurance reimbursement may trigger a capital gains tax liability. If the amount of insurance or other reimbursements you receive is in excess of the cost or adjusted basis of your damaged property, that will be considered as a capital gain. You must then include that capital gain as income unless you’re otherwise allowed to postpone reporting the gain. If, within the designated replacement period, you’re successful at purchasing a property that’s similar in service or use to the one that was damaged, postponement of your reporting obligation may be allowed. You’re also entitled to a postponement if you purchase a controlling interest of 80% or more in a corporation which owns similar property or if you use the reimbursement monies to fix your original property.
Remember that it’s also possible to offset casualty gains with casualty losses you incurred, independently of the federal disaster event. This is the only way you can deduct personal-use property casualty losses incurred in areas not declared disaster areas.
Calculating the Casualty Loss and Deduction Amounts
Here are some general guidelines to follow that will help you determine whether or not your damaged property might yield you a casualty loss tax deduction. If you have damaged (but not completely destroyed) property that is earmarked for personal use, business use, or to produce income, you can determine your casualty loss by taking the lesser of:
- The adjusted basis of the property immediately before the loss (generally, your original cost, plus improvements and less depreciation), or
- The decrease in fair market value (FMV) of the property as a result of the casualty (that is, the difference between the FMV immediately before and immediately after the casualty).
The amount of the loss for either completely destroyed business use or income-producing property is the adjusted basis less any salvage value and reimbursements.
If you’ve had damage to multiple pieces of property that occurred from one disaster event, you are required to separately calculate the loss on each of the damaged properties. By combining all of your losses, you can figure out the total casualty loss amount.
Personal use property is viewed a bit differently. In this case, the entire property and improvements made to it are looked upon as a single item. Taking the lesser amount between the entire property’s depreciation in FMV and the entire property’s adjusted basis will give you your total loss amount. In addition, you will need to deduct an additional $100 (after any salvage value and reimbursement amount has been subtracted) for each personal use casualty you are attempting to claim. Also, each taxpaying owner of a single personal use property must subtract the $100. Finally, after the $100 reduction has been applied, you’re also required to reduce your total casualty losses by 10% of your adjusted gross income. Every casualty loss you experience over the course of the tax year will need to be separately reported to the IRS in order for you to claim the casualty loss tax deduction.
Keeping Good Records
As with any taxable situation, keeping good documentation can make the difference between your receiving the casualty loss tax deduction or not. Your records must reflect the fact that you owned the property you’re looking to claim the deduction for or were contractually liable to the owner for the damage exacted of a property you leased that qualifies for the casualty loss deduction. You’ll need to document the type of casualty and when it occurred. You’ll also still be obligated to show proof that the loss was a direct result of a disaster casualty. Reimbursement documentation that details whether a claim with a reasonable expectation of recovery is evident is also important to have on hand.
You must be able to establish your adjusted basis, reimbursements, and for personal-use property, pre-and post-casualty FMVs.
Relief May Affect Your Tax Filing Deadlines
Due to the frequency and extent of disaster events in the U.S. this year, the IRS has granted tax relief to victims in many states which may allow for the extension of your typical filing deadlines (visit: https://bit.ly/3nzF2ui to see if your state is affected). The relief typically extends filing and other deadlines. You don’t necessarily need to have a home, business, or income-producing property located in a state that’s been declared a federal disaster area to qualify for the relief. If the information you need to complete your timely filing is located in an impacted area and you are unable to get your return completed due to those factors, you may qualify for filing and payment relief.
If you have experienced a natural disaster that’s affected your property this year and you’re uncertain as to whether or not you may be eligible for the casualty loss deduction or qualify for tax relief, contact your Untracht Early advisor for assistance.