All too often we hear of damage caused by floods, fires, and other natural disasters. Special tax law provisions may help taxpayers and businesses recover financially from the impact of a disaster, especially when the federal government declares their location to be a major disaster area.
In general, taxpayers who suffer an economic loss due to a casualty may claim a deduction on their federal income tax return. A casualty is the damage, destruction or loss of property resulting from an identifiable event that is sudden, unexpected or unusual. For tax years 2018 through 2025, if the taxpayer is an individual, casualty losses of personal-use property are deductible only if the loss is attributable to a federally declared disaster (federal casualty loss).
Limitation on personal casualty and theft losses
Personal casualty and theft losses of an individual, sustained in a tax year beginning after 2017, are generally deductible only to the extent they are attributable to a federally declared disaster. The loss deduction is subject to the $100 limit per casualty and 10% of adjusted gross income (AGI) limitation. An exception to the rule above, limiting the personal casualty and theft loss deduction to losses attributable to a federally declared disaster, applies if the taxpayer has personal casualty gains for the tax year. In this case, the taxpayer will reduce their personal casualty gains by any casualty losses not attributable to a federally declared disaster. Any excess gain is used to reduce losses from a federally declared disaster. The 10% AGI limitation is applied to any remaining losses attributable to a federally declared disaster. However, for certain federal disasters in 2017, 2018 or 2019, the 10%-of-AGI threshold is eliminated, but the $100 floor is increased to $500.
Disaster Area Losses
A federally declared disaster is a disaster that occurred in an area declared by the President to be eligible for federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. It includes a major disaster or emergency declaration under the Act. Individual taxpayers who suffered casualty losses in these covered disaster areas can deduct those losses on their current or previous year income tax returns.
How do taxpayers calculate the casualty loss deduction?
Taxpayers calculate the amount of a casualty loss by:
- determining the adjusted basis in the taxpayer’s property before the disaster;
- determining the decrease in the property’s fair market value after the disaster; and
- subtracting any insurance or other reimbursement the taxpayer receives from the smaller of the amounts in (1) and (2).
When can taxpayers claim a casualty deduction?
Taxpayers can elect to deduct disaster losses on either their:
- original or amended current year return; or
- an amended previous year return, if the taxpayer paid taxes for that year.
Individual taxpayers must complete Form 4684 to make the election and determine their casualty loss deduction. Taxpayers electing to deduct losses on their previous year return should include a statement indicating that they are making that election by adding the disaster designation, on the top of the form. The election must be made no later than six months after the original due date for filing their current year return.
If the taxpayer’s home is located in a federally declared disaster area, the taxpayer can postpone reporting the gain if they spend the reimbursement to repair or replace the home. Special rules apply to replacement property related to the damage or destruction of the taxpayer’s main home (or its contents) if located in these areas.
Insurance Proceeds and Other Reimbursement
If the taxpayer receives an insurance or other type of reimbursement, they must subtract the reimbursement when they figure their loss. A taxpayer does not have a casualty or theft loss to the extent they are reimbursed. If in the year of the casualty there is a claim for reimbursement with a reasonable prospect of recovery, the loss isn’t sustained until they know with reasonable certainty whether such reimbursement will be received. If the taxpayer expects to be reimbursed for part or all of their loss, they must subtract the expected reimbursement when they figure their loss. The taxpayer must reduce their loss even if they don’t receive payment until a later tax year.
Reconstructing records after a disaster may be essential for tax purposes, getting federal assistance or insurance reimbursement. After a disaster, taxpayers might need certain records to prove their loss. The more accurately the loss is estimated, the more loan and grant money there may be available. For taxpayers who have lost some or all of their records during a disaster, there are some simple steps to take that can help. The following information includes steps to take after a disaster, so taxpayers can reconstruct their records and prove loss of personal-use and business property.
Taxpayers who are participants in 401(k) plans, employees of public schools and tax-exempt organizations with 403(b) tax-sheltered annuities, as well as state and local government employees with 457(b) deferred-compensation plans may be eligible to take advantage of streamlined loan procedures and liberalized hardship distribution rules.
Please don’t hesitate to call if we can help you in your time of need. We can answer questions regarding your tax situation and identify available resources for a smooth recovery. View our Tax Advisory Services Group.
You may also be interested in our blog post about new opportunities for business R&D tax credits.