How to Salvage a Casualty Loss Deduction

So far, 2021 has been a rough year for casualty losses. Hurricane Ida wreaked havoc in the south and east. Wildfires have destroyed millions of acres in the west. Catastrophes in other parts of the country this year — including tornadoes, earthquakes and floods — have caused significant damage to personal property.

tornado in a field near houses

But there may be a silver lining to these dark storm clouds: Casualty victims who have suffered economic loss may be eligible for tax deductions on their 2021 return. In fact, some victims may even benefit from special expedited tax relief measures, if certain requirements are met.

History Lesson

The Tax Cuts and Jobs Act (TCJA) imposed new tax restraints on deductions for casualty and theft loses. The changes went into effect in 2018 and are scheduled to continue through 2025, unless Congress extends the current rules or revises them.

Prior to the TCJA, to qualify for a deductible casualty loss, tax law regulations required damage or destruction to result from a "sudden, unexpected, or unusual" event. Typically, losses were caused by natural disasters, such as hurricanes or tornados. But losses may also have been attributed to incidents such as automobile collisions or water pipes bursting during a winter freeze.

Furthermore, if your personal property was vandalized or stolen, a loss due to the vandalism or theft could be deducted along with casualties from natural disasters and other catastrophes. But no deduction was allowed for losses due to normal "wear and tear" or progressive deterioration.

Under the TCJA, deductions for personal casualty and theft losses have been suspended until 2026. However, there's a key exception: You may still deduct personal casualty losses, subject to the usual rules, sustained in an area officially designated as a "federal disaster area" by the president. This relief is available for damage caused by many natural disasters, including Hurricane Ida.

Be aware, however, that other special limits apply to casualty loss deductions, even if damage is incurred in a federal disaster area.

How Much Can You Deduct?

If your personal property is partially or completely destroyed, the amount of the casualty loss for tax purposes is the lesser of:

Important: If your property produces income — such as rental payments — and is completely destroyed, the amount of your loss is limited to your adjusted basis in the property.

The adjusted basis of your property is usually your cost, increased or decreased by certain events, such as improvements or depreciation. For instance, if you bought a home for $500,000 and you've added an in-ground swimming pool and deck for $100,000, your adjusted basis in the home is $600,000.

In addition, the deductible loss must be reduced by any insurance or other reimbursements you receive or expect to receive. If your property is covered by insurance, file a timely claim for reimbursement. Otherwise, you can't deduct the casualty loss.

Then, after you've determined the amount of the loss, you must figure how much you can deduct. The tax writeoff is limited by the following two key rules:

  1. You can deduct only the excess above 10% of your adjusted gross income (AGI).
  2. You must reduce the amount of the loss by $100 for each separate casualty or theft loss event.

For example, suppose your AGI for 2021 is $100,000 and your loss in a federal disaster area, after insurance reimbursements, is $15,000. On these facts, your deduction is limited to $4,900 [$15,000 – (10% × $100,000) – $100].

Special rules for 2020: Subsequent to the TCJA, Congress temporarily revised the rules for certain time periods. Notably, it eliminated the usual 10%-of-AGI threshold, while increasing the $100-per-event floor of $500, for qualified disaster-area losses incurred in 2020. However, the standard limits will remain in effect for 2021, unless Congress enacts further legislation.

When Is the Loss Deductible?

Normally, you can only deduct a casualty loss on the tax return for the tax year in which the casualty actually occurred. This is true even if you don't repair or replace the damaged property until later. For example, if your basement floods from a hurricane in 2021, the resulting loss is usually deducted on the 2021 return you'll file in 2022.

However, under long-standing rules, if you sustain damage to personal property in a federal disaster area, you can elect to claim the available casualty loss on the tax return for the tax year preceding the year of the event.

So, if you incur a loss in a federal disaster area loss before the end of this year, you might amend your 2020 return to obtain faster tax relief by claiming a refund. You don't have to wait until you file your 2021 return.

Similarly, if you incur a disaster-area loss early in 2022, you can claim the loss on your 2021 return to obtain faster tax relief.

What's Right for You?

If you qualify for a casualty loss deduction, you must include it on Schedule A of your federal income tax return, along with other itemized deductions. Therefore, taxpayers who claim the standard deduction get no tax benefit from casualty losses. For more information, contact your tax advisor, who can explain the details and help you maintain accurate records and evidence to support the amount of your deductible loss.

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