Hurricanes, tornadoes, fires — Catastrophic disasters seem to occur more frequently every year. People don’t think about taxes when they are dealing with the havoc of property destruction or damage. The IRS offers relief for some taxpayers with casualty losses, but as usual, the rules are complicated. We’ll cover some important aspects about deducting personal casualty losses on your income tax return.
A casualty occurs when your property is damaged as a result of any sudden, unexpected or unusual event such as a flood, hurricane, tornado, fire, earthquake, car accident or vandalism. The meaning of “sudden, unexpected or unusual” is one of the most controversial aspects of a casualty loss deduction. A number of IRS rulings have disallowed casualty events, even when the damage becomes suddenly apparent. Examples of losses that have been disallowed include:
- A fire that has been willfully set
- A car accident caused by a willful act or negligence
- Progressive deterioration, such as a water heater that bursts after normal wear & tear, or a wall that collapsed due to gradual erosion from normal weather conditions
- Disease or insect damage to trees, shrubs and other plants
- Damage created by a pet (example: a rug ruined by a puppy before it was housebroken)
- Accidentally breaking china or glassware during everyday use
You may be able to deduct qualifying casualties of personal items such as your home, household items, vehicles and other items you own for your personal use. Individuals are required to claim their casualty losses as an itemized deduction on Schedule A. You must be able to support the amount you take as a deduction.
There are a number of calculations to determine what deduction you will be entitled to. The amount of loss you must consider for each piece of property is the lesser of:
- The adjusted basis of the property before the casualty, or
- The decrease in fair market value of the property as a result of the casualty
You must follow these steps:
- Figure the loss after reimbursement: For each casualty event, subtract any salvage value and any insurance or other reimbursement for each damaged item.
- Apply $100 rule: Subtract $100 from each casualty event.
- Apply 10% AGI limitation: Summarize net losses for all casualty events after applying the $100 rule in Step 2. Subtract 10% of your adjusted gross income from this total.
Now you have the amount you can take as an itemized deduction for the year’s casualty loss.
You must generally deduct casualty losses in the year they occurred. The IRS allows victims of federally declared disaster areas the choice to deduct losses in the immediately preceding year. Taxpayers would amend their prior year’s tax return if it results in lower overall taxes for the two years.
Tax relief will not completely restore the financial hardship or solve emotional suffering caused by a disaster. Still, consulting with a tax professional is always worth pursuing. Gary Kaplan can help you explore potential tax benefits if you are ever faced with this situation.
