Suffering a disaster loss from a fire, storm or theft can be very traumatic for your clients and their families. As their friend and trusted advisor, you can provide them with emotional support, financial guidance and help with the tax implications.
Fortunately, the Internal Revenue Code allows taxpayers to deduct disaster losses, and that can help to ease the financial burden. Please share these IRS tips with your clients, or use the information to guide your clients in the aftermath of a disaster:
- Casualty loss. A taxpayer may be able to deduct a loss based on the damage done to their property during a disaster. A casualty is a sudden, unexpected or unusual event. This may include natural disasters such as hurricanes, tornadoes, floods and earthquakes. It can also include losses from fires, accidents, thefts or vandalism.
- Normal wear and tear. A casualty loss does not include losses from normal wear and tear. It also does not include progressive deterioration from age or termite damage.
- Covered by insurance. If taxpayers insured their property, they must file a timely claim for reimbursement of their loss. If they don’t, they cannot deduct the loss as a casualty or theft. Reduce the loss by the amount of the reimbursement received or expected to receive.
- When to deduct. As a general rule, deduct a casualty loss in the year it occurred. However, if taxpayers have a loss from a federally declared disaster, they may have a choice of when to deduct the loss. They can choose to deduct it on their return for the year the loss occurred, or on an original or amended return for the immediately preceding tax year. This means that if a disaster loss occurs in 2017, the taxpayer doesn’t need to wait until the end of the year to claim the loss. He or she can, instead, choose to claim it on the 2016 return. Claiming a disaster loss on the prior year’s return may result in a lower tax for that year, often producing a refund.
- Amount of loss. Figure the amount of loss using the following steps:
- Determine the adjusted basis in the property before the casualty. For property taxpayers, the basis is usually its cost to them. For property they acquire in some other way, such as inheriting it or getting it as a gift, the basis is determined differently. For more information, see Publication 551, Basis of Assets.
- Determine the decrease in fair market value (FMV) of the property as a result of the casualty. FMV is the price for which a person could sell a property to a willing buyer. The decrease in FMV is the difference between the property’s FMV immediately before, and immediately after, the casualty.
- Subtract any insurance or other reimbursement received, or expected to receive, from the smaller of those two amounts.
- $100 rule. After figuring the casualty loss on personal-use property, reduce that loss by $100. This reduction applies to each casualty-loss event during the year. It does not matter how many pieces of property are involved in an event.
- 10 percent rule. Reduce the total of all casualty or theft losses on personal-use property for the year by 10 percent of the taxpayer’s adjusted gross income.
- Future income. Do not consider the loss of future profits, or income due to the casualty.
- Form 4684. Complete Form 4684, Casualties and Thefts, to report the casualty loss on a federal tax return. Claim the deductible amount on Schedule A, Itemized Deductions.
- Business or income property. Some of the casualty loss rules for business or income property are different from the rules for property held for personal use.