How tax reform tightened the casualty-loss rules for disasters
Each season of hurricanes, wildfires, tornadoes, and other disasters seems worse than the season before. Many of your clients probably believe that the cost of anything they lose to a disaster can still be fully deducted. However, the fact is that the Tax Cuts and Jobs Act (TCJA) has made taking those deductions a little tougher.
Under previous tax law, your client could claim personal casualty losses (at least those uncompensated for insurance or other means) as itemized deductions. The TCJA slapped on that personal casualty losses can now be deducted only in the case of a federally declared disaster.
Not all areas hit by a federally declared disaster are federally declared disaster areas. Congress has stepped in to ease tax restrictions after some past disasters – but by no means should you and your clients depend on this.
Definitions of casualty loss
A casualty loss can result from the damage, destruction, or loss of property from, according to the IRS, “any sudden, unexpected, or unusual event,” such as a flood, hurricane, tornado, fire, earthquake, or volcanic eruption. Other potentially qualifying events include mudslides, wildfires, car accidents, vandalism, terrorist attacks, and “incidents of civil unrest.”
In the case of a federally declared disaster, your client can deduct casualty losses in the year the disaster occurs or, using an amended return, in the prior tax year. After the filing due date for the year of the loss, your client has six months to decide what year to claim the deduction.
A casualty doesn’t include normal wear and tear, or progressive deterioration. If your client’s property is personal-use property or isn’t completely destroyed, the amount of the casualty loss is the lesser of the adjusted basis of the property or the decrease in fair market value of the property. Condos and co-ops do not count as personal residences if your client doesn’t own the structural components, or owns a fractional interest in the structural components; trailers and mobile homes also don’t count.
If the property is a business or income-producing property and is completely destroyed, the amount of your client’s loss is their adjusted basis.
Your client can’t deduct losses covered by insurance unless they filed a timely claim for reimbursement. They have to reduce the loss by the amount of any reimbursement or expected reimbursement.
Your client has to determine the difference between the fair market value immediately before and immediately after the casualty and the adjusted basis of the property. Decrease in the fair-market value can be determined by appraisal or, under certain conditions, by the cost of repairing the property.
Casualty and theft losses are claimed as itemized deductions. Of course, it is now harder to itemize after the TCJA’s increase in the standard deduction. In addition, since your client can no longer claim miscellaneous itemized deductions, business casualty losses of property used in performing services as an employee cannot be deducted or used to offset gains.
You subtract $100 from each casualty or theft event that occurred during the year after subtracting salvage value and insurance or other reimbursement. Next, add those amounts and subtract 10 percent of your client’s adjusted gross income to calculate the allowable losses for the year. Report casualty and theft losses on Form 4684, Casualties and Thefts, using Section A for personal-use property and Section B for business or income-producing property.
Rev. Procs. 2018-8 spells out five safe harbors for taxpayers to measure a decline in the fair-market value of “personal-use residential real property” that incurs a casualty. Only the first three safe harbors may be used by taxpayers who suffer casualties from anything other than federally declared disasters.
- Estimated repair costs: For losses of $20,000 or less [prior to the limits of Sec. 165(h)], use the lower of two itemized repair estimates provided by independent licensed or registered contractors.
- De minimis: For losses of $5,000 or less [prior to the limits of Sec. 165(h)], prepare good-faith estimates of the cost of repairs.
- Insurance: The amount of loss as determined by the carrier.
- Contractor: Use the itemized cost of repairs detailed by an independent licensed or registered contractor, and included in a binding, signed contract.
- Disaster loan appraisal: An appraisal that estimates losses, and is prepared for securing a federal loan or a loan guarantee from the federal government.
Taxpayers may also calculate losses to their belongings by using the current replacement value comparison. This is the current cost to replace a belonging with a new item minus 10 percent of the replacement cost, multiplied by the number of years the item was owned, to a minimum of 10 percent of replacement cost, minus the item’s fair-market value immediately after the casualty.
Additional items of interest in the wake of disasters:
- If your client has a personal casualty capital gain for the tax year, they may be able to deduct the portion of the personal casualty loss that’s not attributed to a federally declared disaster area, to the extent that the loss doesn’t exceed the personal capital gain.
- If your client’s loss deduction is more than their income, they may have a net operating loss (you don’t have to be in business to have a net operation loss from a casualty).