When disaster strikes whether natural or man-made homeowners, renters, and business owners may find themselves dealing with damage, destruction, or loss of property. Under certain circumstances, it’s possible to claim a tax deduction for these casualty losses. The Tax Cuts and Jobs Act (TCJA) generally suspends write-offs for such expenses for 2018 through 2025.
However, you can still claim deductions for personal property losses caused by certain federally declared disasters. In addition, Congress has provided enhanced deductions for eligible individuals in some disaster-relief legislation for limited periods. Here are the details.
A casualty loss refers to damage, loss, or destruction of property resulting from a sudden, unexpected, or unusual event such as a hurricane, flood, fire, earthquake, or other disaster.
Importantly, for most taxpayers, only losses from federally declared disaster areas are eligible for deduction for tax years 2018 through 2025. Losses covered by insurance or for which reimbursement is expected generally are not deductible.
Before the TCJA, personal casualty and theft losses outside disaster zones could be deductible if they arose from a sudden, unexpected, or unusual event. But under current law, everyday losses such as theft, vandalism, accidental damage or similar events generally don’t qualify unless they’re tied to a federally declared disaster.
Previously, personal casualty and theft losses even outside disaster zones could be deductible if they arose from a sudden, unexpected, or unusual event, such as fires, storms, thefts or automobile collisions.
Taxpayers deducted the lesser of either their property’s adjusted basis or the drop in fair market value, minus any insurance reimbursements. Then, for each loss event, they reduced the result by a fixed amount and finally by 10% of adjusted gross income (AGI).
With the passage of the TCJA, personal casualty and theft losses generally became non-deductible unless the loss stems from a federally declared disaster.
As a result, many losses that previously qualified, such as theft, vandalism or accidental damage, are no longer deductible for personal-use property unless they are tied to a qualifying disaster.
When you do qualify, the deduction is generally determined as follows:
If the result is zero or negative, no deduction is allowed.
The adjusted basis of your property is usually your cost, increased or decreased by certain events, such as improvements or depreciation. For example, if you bought a home for $500,000 and later added improvements costing $100,000, your adjusted basis would generally be $600,000.
If your property produces income, such as rental payments, and is completely destroyed, the amount of the loss is generally limited to your adjusted basis in the property.
If your property is covered by insurance, you should file a timely claim for reimbursement. Otherwise, you may not be allowed to deduct the casualty loss.
Normally, you claim the casualty loss in the tax year in which the disaster occurred.
However, for federally declared disasters, there’s a special election that allows you to claim the loss on the return for the year preceding the disaster if that timing results in a greater tax benefit or faster tax relief. Depending on when the disaster occurs, this may allow you to amend the prior year’s return and potentially receive a refund sooner.
A key and often overlooked risk is that if you receive insurance proceeds that exceed your property’s tax basis, you may end up with a taxable involuntary conversion gain instead of a deductible loss.
For a principal residence destroyed in a disaster, special rules may allow you to exclude up to $250,000 of gain, or up to $500,000 for married couples filing jointly, if you’ve owned and used the home as your main home for at least two of the previous five years.
If you still have a gain after the exclusion, you may be able to defer the taxable gain by reinvesting the proceeds in similar property, usually within two years, or within four years for principal residences in disaster areas.
Losses due to normal wear and tear, gradual deterioration, insect or mold damage, misplaced items, lost money, or damage that isn’t sudden or unusual generally don’t qualify.
If insurance covers the loss and you fail to file a timely claim, your deduction may be reduced or disallowed.
Taxpayers who don’t itemize generally can’t claim any tax benefit from casualty losses, unless the loss falls under temporary special disaster-relief provisions that override the usual rules.
Due to the changes introduced by the TCJA, most personal losses from vandalism, theft and gradual damage do not qualify for a federal tax deduction. Only casualty losses tied to federally declared disasters may be deductible. For business or income-producing property, deductions are more accessible.
Before you claim anything, you should:
If you qualify for a casualty loss deduction, maintain accurate records and evidence to support your deduction in case the IRS ever challenges the write-off.
What happens if your business property, rather than your personal-use property, is stolen, destroyed or otherwise damaged by vandalism or another event? The rules for deducting business casualty and theft losses are generally similar to those for personal property losses, with a few notable exceptions.
Most important, the limits for individual casualty and theft loss deductions don’t apply. In other words, you don’t have to worry about the $100-per-event reduction or the 10%-of-AGI threshold. In general, business casualty and theft losses are fully deductible, regardless of whether the damage occurred in a federal disaster area. However, business losses are still subject to other restrictions, such as those related to salvage value and insurance reimbursements.
As with income-producing property, if business property is destroyed, the amount of your loss is generally your adjusted basis in the property. Any decrease in fair market value usually doesn’t come into play.
Casualty loss deductions can be valuable, but only if you meet the strict rules. Whether a loss is deductible depends on the type of property, the cause of the damage, whether the event occurred in a federally declared disaster area, how much insurance you received, and whether you itemize deductions.
If you think you may qualify, contact your tax advisor, who can explain the rules, help you determine the best year to claim the loss, and assist you in maintaining the records needed to support the deduction.
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