The Deductibility of Casualty Losses

The Deductibility of Casualty Losses

Defining a Casualt= y or Theft Loss
A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. It does not incl= ude damage from events that are gradual or damage from routine wear and tear. For exam= ple, a termite infestation, mold damage, or deterioration from normal wind and weather do not qualify as casualties.

The cost of repairing damaged property, restoring landscaping to its original condition= , or the cost of cleaning up after a casualty is not part of your deductible los= s. If the repairs meet certain conditions, however, you may be able to use the= se costs as a measure of the decrease in fair market value of your property. Y= ou can use repairs as a measure of decrease in fair market value if all of the following are true:

The repairs are necessary to restore the prop= erty to the condition it was in immediately before the casualty =

The amount spent for repairs is not excessive=

The repairs only correct the damage caused by= the casualty

The value of the property after the repairs is not, as a result of the repairs, more than the value of the property immediately before the casualty

You also c= annot deduct the loss of future profits or income due to the casualty. For exampl= e, if the prices of homes in your neighborhood drop after a widespread flooding near your area, the decline in market value of your home is not a casualty loss.

A theft includes, but is not limited to, the taking of money or property by blackma= il, burglary, embezzlement, extortion, kidnapping for ransom, larceny, or robbe= ry. The taking of money or property through fraud or misrepresentation is theft= if it is illegal under state or local law. Generally, you cannot deduct the lo= ss of property that has been simply lost or mislaid. However, if the accidental loss or disappearance of property results from a casualty, it could be deductible depending on the circumstances.

Expenses y= ou incur for preventative measures against casualties and theft are not deduct= ible as losses. Examples of preventative measures are boarding up your house bef= ore a hurricane, building a levee to prevent future flooding, or installing a security system after a break-in. Instead, you might be able to capitalize = some of these expenses, if they are for permanent improvements, and add them to = the basis of your property.

Incidental expenses you have as a result of a casualty or theft ar= e not deductible as part of your loss. Incidental expenses include the cost of medical treatment for personal injuries, the cost of temporary housing or h= otel fees, or the cost of renting a car.

Proving a Loss
To deduct a casualty or theft loss, you must be able to prove to= the IRS that:

You owned the property or you are contractual= ly responsible to the owner for any damage to the property

There was an event that directly caused your = loss (indicate the type of casualty and when it occurred, or indicate it wa= s a theft and when it was discovered)

You must a= lso show the IRS whether there is any reimbursement or recovery you can obtain = for the property.

Save any p= olice reports, newspaper articles, photographs or videos, bills of sale, receipts= for improvements or repairs, payment checks, deeds, professional appraisals, co= pies of insurance claims, and insurance adjuster appraisals to support any casua= lty loss deduction you take on your return. If obtaining a professional apprais= al is not cost-effective or possible, you may also be able to establish fair market value by using comparable classified ads or industry standard "= blue book" values (for automobiles).

As a gener= al rule, you should always keep any documentation to support the basis or fair market value of your property separate from your property. Keep copies with= a family member, a friend, or in your safe deposit box to prevent loss of the= se documents when your property is damaged, destroyed, or stolen.

Personal Casualty or Theft Losses
Generally, if a single casualty or theft involves more than one i= tem of property, you must calculate the loss on each item separately. Then comb= ine the losses to determine the total loss from that casualty or theft. When calculating a casualty loss on personal use real property, however, the ent= ire property is treated as one item. For example, your entire property could include your storage shed, fence, trees, and shrubs in addition to your hom= e.

Calculate = your loss by using the smaller of the following:

The decrease in fair market value of the enti= re property (fair market value is the price for which you could have sold= the property to a willing buyer if neither of you had to sell or buy the property and both knew all relevant facts)

The adjusted basis of the entire property (adjusted basis is usually what you paid for the property, increased or decreased by various events such as improvements or earlier casualty losses)

Reduce you= r loss by any insurance or other reimbursement you receive or expect to receive.

You must f= urther reduce your loss by $100. This $100 reduction applies to each casualty or t= heft event that occurred during the year, regardless of how many items of proper= ty are involved. The total of all your casualty and theft losses of personal u= se property for the year must then be reduced by 10% of your adjusted gross income. The balance that remains after making these reductions is the amoun= t of your deductible casualty or theft loss of personal use property.

If you use= an appraisal to support your determination of the fair market value of your property, you can deduct the cost of getting an appraisal separately on Schedule A as a miscellaneous itemized deduction subject to 2% of your adju= sted gross income.

Deduct you= r loss in the year that the casualty occurred or the theft was discovered. If you = have not received your insurance reimbursement at the time of your tax preparati= on, you can estimate the amount you expect to receive and use that amount on yo= ur tax return. If the reimbursement amount differs from what you expected, you= may have to make an adjustment to your return in the year you actually receive = the reimbursement. If you are not sure whether part of your casualty or theft l= oss will be reimbursed or recovered, do not deduct that part until the tax year when you become reasonably certain that it will not be reimbursed or when y= ou have a reasonable estimate of the amount of reimbursement.

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Personal Casualty or Theft Gain
You may have a gain if you receive more in reimbursement than the basis of the destroyed or damaged property:

If you receive similar property as reimbursem= ent, a gain generally does not need to be reported.

If you receive unlike property or money as reimbursement, you may have to pay tax on the gain. =

If the gain results because your principal residence was destroyed, you are allowed to treat it as if you had sold your residence and can exclude up to $250,000 ($500,000 if Married Fil= ing Jointly) if you otherwise meet the conditions for the exclusion. =

You genera= lly can choose to postpone all or part of the taxable gain if, within two years= of the end of the first tax year in which any part of the gain is realized, you purchase similar property or property related in service or use to the dama= ged, destroyed, or stolen property.

Federal Disaster Losses
If= the president of the Uni= ted States has declared your area a federal disaster area, you have a choice of which year you may claim the loss:

You may claim the loss for the year in which = it occurred if you file your current-year tax return by the due date (with extensions)

You may amend your prior year tax return by filing Form 1040X, Amended U.S. Individual Income Tax Return, a= nd claim losses in the previous tax year. Specify the date or dates of the disaster and the city, town, county, and state where the property was damaged or destroyed on your amended return. Write the disaster's name= in red ink on the top of the return.

By amendin= g your return, you can get your refund for the loss sooner than waiting until the following year. However, you should compare your tax situation and adjusted gross income for both years to determine if it is to your tax advantage to claim the loss in one year rather than another.

If your ho= me is located in a presidentially declared disaster a= rea and your state or local government orders you to tear it down or move it because it is no longer a safe place to live, the resulting loss in value is treated as a casualty loss from a disaster. For you to deduct the loss, the order must have been issued within 120 days after the area was declared a disaster area.

The IRS may postpone for up to one year certain tax deadlines of taxpayers who are affe= cted by a presidentially declared disaster. The tax deadlines the IRS may postpone include those for filing income, estate, gif= t, generation-skipping transfer, certain excise, and employment tax returns, paying taxes associated with those returns, and making contributions to a traditional IRA or Roth IRA. If the IRS postpones the due date for filing y= our return and for paying your tax and you are affected by a presidentially declared disaster area, the IRS may abate the interest on underpaid tax that would otherwise accrue for the period of the postponement.

Federal Disaster Gains
Sp= ecial rules apply if your home is located in a presidentiall= y declared disaster area. Some of these rules include:

Unscheduled Property - Any insurance proceeds= you receive for unscheduled personal property in your home are not taxable. Unscheduled property is anything in your home not listed separately on your insurance policy, such as furniture or clothing.

Other Property - Other insurance proceeds from damage to your home and its contents are considered for a single item = and are lumped into a single sum. The proceeds may result in a taxable gai= n if the amount is greater than your loss. If the amount of insurance or ot= her reimbursement exceeds the amount you paid for similar replacement prop= erty purchased within the replacement period, you may recognize a gain that= is considered taxable income.

Replacement period - Instead of the usual two years, the law provides for a four-year replacement period for replaci= ng principal residences damaged due to a federal disaster.

Renters receiving insurance proceeds for damaged or destroyed property qualify for similar relief if their rented home is their primary residence.

Reimbursement
A reimbursement is a money payment specifically allocated to replace or repair the property through insurance or other IRS-approved meth= ods. Reimbursements may reduce the amount of loss you may claim on your return. = The following qualify as reimbursements:

Insurance

The part of a federal disaster loan that you = are not required to pay back

Court-awarded damages minus legal fees and ot= her necessary expenses

Repair, restoration, or clean-up services provided by relief agencies like the Red Cross

Condemnation awards

A theft loss paid by a bonding company <= /o:p>

Grants and other payments you receive to help= you after a casualty

Note: Grants and other payments are considered reimbursements only if = they must be used specifically to repair or replace your property. For exam= ple, payments from an employer's emergency disaster fund that are earmarked= for restoration or replacement of damaged property are considered reimbursements.

If individ= uals such as your neighbors, friends, or relatives give you cash and do not place restrictions on how you should spend the money, these cash gifts are not included in your income and they do not reduce the amount of your casualty loss.

Food, medi= cal supplies, and other forms of relief assistance you receive do not reduce yo= ur casualty loss, unless the assistance replaces your lost or destroyed proper= ty.

Reimbursem= ents that exceed your losses or exceed the additional expenses you incur because= of the casualty or theft may have to be included in income.<= /p>
For exampl= e, the house Belinda rents was damaged due to a tornado. Her town is not designate= d a disaster area. Her insurance company determined it was not safe for her to = live in the house until the roof, walls, and carpeting are repaired or replaced,= so the insurance agent has approved a $3,000 payment for temporary housing expenses. This reimbursement does not reduce her casualty loss, because it = is not a payment made to repair or restore property. Belinda moves into an apartment for four months while the house is being restored. Her rent is usually $900 per month, but she must pay $1,100 for rent for the apartment because it is a short-term lease. The $800 additional rent expense she incu= rred [($1,100 apartment rent - $900 house rent) × 4 months] is considered a tax-free reimbursement. Belinda also had to stock up on groceries again and spent $300 more than she normally would have. The apartment is farther away from work, so she paid $40 more in gasoline than she normally would have. T= he remaining $1,860 reimbursement ($3,000 - $800 - $300 - $40) should be inclu= ded as income on Belinda's return. Her insurance company also reimburses her for the personal property contained in the rental house that was damaged. Her reimbursement for the various pieces of furniture totaled $5,000. When she calculates the casualty loss on her return, she must reduce her loss by this reimbursement. Any reimbursement in excess of her loss should be included as income on her return.

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Disaster Relief Grants and Payments
Do= not include post-disaster grants received under the Disaster Relief and Emergen= cy Assistance Act in your income if the grant payments are made to help you me= et necessary expenses or serious needs for medical, dental, housing, personal property, transportation, or funeral expenses. Any losses or expenses that = are specifically reimbursed by these disaster relief grants cannot be used in determining the amount of your casualty or theft loss. Unemployment assista= nce payments under the act are considered taxable unemployment compensation.

Individual= s who are disaster victims generally do not have to pay taxes on certain assistan= ce payments they receive. This exclusion from income applies only to expenses compensated by assistance payments that are not otherwise compensated for by insurance or other sources.

A qualified disaster relief payment includes any amount paid to or for the benefit of an individual that is either:

A reimbursement or payment for reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster

A reimbursement or payment for reasonable and necessary expenses incurred for the repair or rehabilitation of a pers= onal residence or repair or replacement of its contents to the extent that = the need for the repair, rehabilitation, or replacement is attributable to= a qualified disaster

A payment made by a federal, state, or local government, agency, or subsidiary, in connection with a qualified disaster, in order to promote the individual's general welfare

A qualified disaster must be one of the following:

A disaster that results from a terrorist or military action

A presidentially declared disaster

A disaster resulting from any event that the Secretary of Treasury determines to be of a catastrophic nature <= /o:p>

A disaster that is determined by an applicable federal, state, or local authority (as determined by the Secretary of Treasury) to warrant assistance from the federal, state, or local government, agency, or subsidiary

Therefore, taxpayers in a presidentially declared disaster= area who receive grants from state programs, charitable organizations, or employ= ers to cover medical, transportation, or temporary housing expenses do not incl= ude these grants in their income.