July marks the peak summer season and the high-risk weather season. If you suffer a casualty or loss this season, you can get some relief on your taxes.
Basic Definition of a Casualty
For Federal income tax purposes, a casualty is an unforeseen, sudden or unusual loss or damage to a property you own.
Examples include property loss due to flood, fire, tornado, hurricane, or other extreme weather event. You can also experience a man-made casualty (theft, vandalism, embezzlement, car crashes, etc.)
Calculating Your Loss
For IRS reporting, you can only deduct your property loss as a casualty loss.
You cannot deduct loss of “future earnings” if your business suffers damages due to a casualty. If your loss is to personal property (your home for example suffers hurricane damage), you cannot deduct living expenses if you must rent a temporary living space.
The IRS uses a very conservative approach for measuring loss. To calculate the loss, the IRS rule requires that you use the lesser of the property’s:
- adjusted basis* value just prior to the loss, or
- loss in fair market value as a result of the casualty
*Note: The IRS defines the “adjusted basis” for property value as the total of the property’s purchase price, plus improvements, minus any depreciation deductions (or previous casualty losses).
Reporting the Loss
You must report your loss (personal or business), to claim the loss. To make this report to the IRS, you need to file Form 4684. You must use this form to report to the agency, the cost of the property lost or damaged due to casualty, disasters or theft. Some income restrictions apply to the amount you can deduct. Your loss must be greater than 10% of your adjusted gross income (AG).
If your property increased in value, you can only deduct the purchase value. If the property has lost value, you must report the lower value.
If the event totally destroyed your property, the value you can report will differ if the property is for personal-use or for business-use.
If your total loss is for personal property, the rule above applies. Either you take the loss based on the adjusted basis value or on fair market value (whichever is less).
If your total loss is for business property (or property that produces income), you must deduct the property’s salvage value from the property’s adjusted tax basis. With business property, you do not account for fair market value.
Proving Your Loss
You must be prepared to prove the loss. You will need documentation that shows:
- You owned the property
- Your property’s adjusted basis value
- Your property’s pre-event value
- Reduction in value due to the casualty, disaster or vandalism, etc.
- The lack or insufficiency of a third-party reimbursement to cover costs*
*Note: If you anticipate a reimbursement from your insurance company (or from a lawsuit) to cover any portion of the loss, you must notify the IRS. You must subtract these reimbursements from your tax-deductible loss, since the deduction only covers unrecoverable losses.
Also, if you can receive an insurance reimbursement but do not file an insurance claim, in order to get a tax deduction, the IRS can disallow that tax deduction.
For personal property, you must also typically deduct $100 (from the amount of your loss) for each casualty, theft or accident you suffered during the year. You must make this $100 subtraction regardless of the number of items damaged or destroyed as a result of the event.
Prepare for Property Casualty or Loss Events
To make this process easier, it helps if you plan ahead. To ease the pain of a major casualty:
- Keep good property records in a safe place such as a safety deposit box
- Inventory home possessions (take pictures of major purchases)
- Purchase adequate insurance (if you live in a flood-zone, purchase flood insurance as most standard insurance policies do not cover floods)
- Keep some cash on hand
We hope you have a safe and trouble-free summer. If you do encounter a loss and need help in computing your tax consequences, contact us.