Hurricane Sandy has brought tremendous devastation to all families along its destructive path. The cost to repair and rebuild will be financially overwhelming. When this type of disaster strikes, a casualty tax loss may provide tax relief (and possible tax refunds) to many taxpayers. The following will provide a basic overview of the tax rules and their related tax limitations.
A deductible loss can result from a number of events. Here are some examples:
A loss must occur within a short period of time, for it to be deductible as a casualty loss. This can raise some difficult factual issues in certain cases. For example, the IRS has said that most droughts lack the suddenness necessary for a casualty loss deduction.
However, there have been some cases if the drought is sudden and it involves reduction of the value of a property as a result of permanent damage to trees, shrubs or damaging the building itself. Winters v. US, DC Oklahoma 1958; Stevens, TC Memo 1984-365.
The conventional tax wisdom has been that, as a practical matter, a casualty loss should not be claimed unless there has been an officially declared water emergency or some general drought designation by the IRS. For example, a casualty loss deduction was allowed for structural damage to a house because of subsoil shrinkage in a 1977 Missouri drought that was declared a federal disaster.
Deterioration that occurs gradually by steadily operating causes do not qualify. For example, weakening of a building by ordinary wind and weather conditions is not a casualty loss. Damage from moths and termites are not considered sudden enough to qualify for a casualty loss.
However, “sudden” infestation of termites and beetles have sometimes been deductible. Rosenberg v Commissioner, 198 F2nd 46 (termites); Black v. Commissioner, 36 TCM 1347 (beetles).
To deduct a casualty loss, the taxpayer must meet all of the following tests and requirements to take a casualty loss:
The allowable deduction for business property destroyed in a casualty is usually different from the loss of personal property.
If the property is used in a trade or business or other activity conducted for profit, the allowable deduction is the lesser of the property’s adjusted basis (before the casualty) or its decline in value because of the casualty.
If business property is completely destroyed, the deduction is the full amount of the property’s adjusted basis, reduced by any insurance recovery, even if the basis exceeded the property’s value before the casualty.
If property owned outside of the business or investment setting, like a personal residence, is damaged, the loss is the lesser of the property’s decline in value or its adjusted basis, reduced by insurance proceeds or other reimbursement.
Unlike business property, if personal property is completely destroyed, the loss cannot exceed the decline in value from the casualty, even if this is less than the basis.
Any casualty loss must be reduced by $100 per casualty.
More importantly such losses are deductible only to the extent that net casualty and theft losses exceed 10 percent of the taxpayer’s adjusted gross income.
Note that the government has eliminated the 10% limitation in federal disaster areas in the past. For example, under the Emergency Economic Stabilization Act of 2008, individuals could take the casualty losses without this 10% reduction. Additionally, these rules retained the $100 limit for 2008 but raised it to $500 for 2009.
It is unclear how the federal government will treat Hurricane Sandy, but it would be surprising if it did not eliminate the 10% threshold in light of the tremendous devastation to taxpayers.
Casualty losses are usually deductible only in the year they occur. This is the case even if the property is not replaced or repaired until the following year.
It is suggested that if the loss cannot be determined before the due date of the tax return, a Form 4868 can be filed for an automatic six month extension of time to file.
Note: If a loss is claimed in one year and an unexpected insurance or other recovery is received in a later year, the amount of the recovery will have to be reported as income in the year obtained. Taxpayers cannot amend the prior year return, even if the return is still open. However, the IRS sometimes provides exceptions as it did under the Gulf Opportunity Zone Property rules.
In federally declared disaster areas, a special rule permits quick tax refunds. Unlike businesses, however, individuals have the option of treating a casualty loss as occurring in the immediately prior year, thereby often allowing for a quick refund through filing an amended return.
To deduct a personal casualty loss, the taxpayer must have filed a timely insurance claim. The loss may be disallowed if the taxpayer fails to file a claim. However, any portion of the loss that is not covered by insurance is not subject to this rule.
A recent court case discusses the requirement to file a timely insurance claim. A homeowner suffered loss of his home from fire. The homeowner immediately notified his insurance company of the loss, was assigned a claim number, and had the insurance company inspect the damage. However, the insurance company denied the claim. One reason it gave was that the homeowner failed to provide a statement as to proof of loss within 60 days, as required under the policy. After the insurance company denied the claim, the homeowner took a casualty loss deduction on his amended tax return. The IRS contested the taxpayers claim. The court did not agree with the IRS. The court said that the homeowner had filed a claim with the insurance company and that was sufficient to comply with the tax code requirements. The court found that a company’s ultimate denial of the claim under the terms of the policy should not prevent the casualty loss to the taxpayer.
Losses that resulted from a taxpayer’s drunk driving are not deductible.
Losses from a taxpayer who deliberately sets a fire to his home cannot take a casualty loss.
If you have suffered a casualty, it is important that you claim the full amount of the tax deduction to which you are entitled. Remember that the above provides only an overview, so if you have any questions about casualty losses, please contact our office.
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