Posted by Michelson Law Office

Understanding How The Tax Deductions For Casualty Losses Work

Understanding How The Tax Deductions For Casualty Losses Work

When a storm destroys your home, or a burglar steals valuables from your home or vehicle, you will likely use insurance to pay for the loss.

Insurance companies pay billions of dollars each year to cover these expenses, known as Casualty losses. Insured losses due to natural disasters in the United States In 2017, reached $78 billion, according to the Insurance Information Institute. This figure reached $91 billion in 2018, reports the National Ocean and Atmospheric Administration.

But sometimes, your insurance does not cover a total loss. Or worse, you cannot have insurance coverage. In this case, it is possible to deduct a casualty loss in the federal income tax return, provided that it meets specific criteria.

What Is A Casualty Loss?

It is essential to understand what casualty loss means and what is not.

Normal wear or gradual deterioration over time does not result in a casualty loss. To qualify as a casualty loss, any damage or loss of property must result from a sudden, unexpected and unusual event, such as a flood, hurricane, tornado, fire, earthquake or volcanic eruption.

For example, if the roof of your house needs to be replaced since its 30 years old, and the insurance does not cover the replacement, it will not be considered a loss for the victims. But if a storm damages the roof, it could be the casualty loss.

The causes of casualty loss may include (but are not limited to, and there are exceptions).

  • Tremors
  • Fires
  • flooding
  • Demolition or transfer of a house by order of the government, because a disaster has made the home unsafe.
  • Sonic boom
  • Storms, including hurricanes and tornadoes.
  • Vandalism
  • Volcanic eruptions

What Is The Deduction For A Casualty Loss?

When a disaster damages your home or personal property, you may be allowed to deduct taxes for Casualty losses, but there are specific rules for those who can make this deduction.

Before the tax reform, any taxpayer who suffers a loss as a result of any casualty and is entitled to a casualty loss tax deduction could deduct it by specifying it in Schedule A. To deduct the loss of ownership resulting from a personal or family accident had to reduce any Casualty loss by $100 and the total had to exceed 10% of the adjusted gross income.

Taxpayers can also deduct losses from theft. The theft must have been considered illegal in the state in which it occurred and was committed with criminal intent. You can only deduct the theft in the year the property was stolen.

If you meet the criteria for a tax deduction for Casualty losses, you can make the deduction regardless of where the loss occurred. The TCJA of 2017 altered the criteria for a deduction. Now, in case of loss, it can determine whether it is deductible or not.

Changes Due To Tax Reform

Tax reform has severely limited the number of people eligible for tax deductions for personal losses.

Only taxpayers whose personal losses occur in a disaster area declared by the federal government can now benefit from a tax deduction for Casualty losses. Then, the President must declare the area disaster area so that losses in that area are deductible.

This provision effectively excludes many events that may have caused deductible losses.

For example, if you suffered material damage from a severe summer storm before the tax reform, you can deduct the loss for that damage (provided you meet all the other deduction criteria for the deduction). However, not all summer storms warrant a federal disaster declaration, and if this does not happen, storm victims in the region will not be able to claim a tax deduction for Casualty losses.

And losses due to theft are only deductible if they can be attributed to a disaster declared by the federal government.

But if you live in a disaster area declared by the federal government, there is good news about tax reform. If you are entitled to a tax deduction for Casualty losses, you can claim it without having to detail the deductions. Your loss should not exceed 10% of the AGI, but the limit of $100 per victim has been raised to $500 per victim.

However, these changes are temporary: the tax reform law applied these amendments only to fiscal years beginning on or after December 31, 2017, and before January 1, 2026. It is also of essence to note that the limitations apply only to the personal losses of the victims, losses due to accidents suffered by a company.

Disaster Zones Declared By The Federal Government

How do you know if your area is considered a declared disaster area by the federal government? The FEMA (Federal Emergency Management Agency) maintains a list of searches by type of incident, type of declaration, and date of the occurrence.

Here is a partial list of the disaster areas declared by the federal government during the events of disaster that occurred in 2018.

  • Alaska earthquake
  • Wildfires in California
  • Alabama, Georgia, and Florida (Hurricane Michael)
  • Virginia (hurricane in Florence)
  • Hawaii (tropical storm Olivia)
  • North Carolina and South Carolina (Hurricane Florence)
  • Hawaii (Hurricane Lane)

FEMA oversees the reporting process for a federal disaster zone. Start with an affected state or tribal government that asks FEMA to conduct a preliminary damage assessment. Some tribal governments may also request a direct statement from the President.

There are two types of declarations.

  • Emergency Statements: The President may issue an emergency declaration when he or she determines that the region in question requires the assistance of the federal government.
  • Significant Disaster Statements: For an emergency to be declared a major disaster, the President must establish that the event has caused such severe damage that local or state governments will not be able to intervene.

How To Apply For A Tax Exemption

Calculating a deduction for accident loss is not as easy as sending receipts, estimating repairs, and asking for a refund. It takes work - starting with determining the actual loss.

Calculation Of The Real Loss

For personal property, such as a house or car, or for other property that is only partially destroyed (the roof is gone, but the walls are still standing), your casualty loss is considered either the adjusted basis of the property or the decrease in the fair market value of the property due to damage.

For commercial property or those that generate income, their casualty loss is the adjusted basis of the property; in case of theft, the loss is usually the adjusted basis of the property.

Calculation Of The Reimbursement Of The Insurance

Once you know the value of your loss, you must deduct any insurance or other refunds received for the damaged property to reach your loss after the return. From this amount, you would deduct $500 (per victim limit). The end product of your calculations should be the tax deduction for your casualty-loss tax deduction.

Let's take a look at an example. Frank's car is seized by a flood in a disaster area declared by the federal government and is therefore added. The adjusted vehicle basis is $12,000 (the proper support is used because it is less than the reduction in the fair market value of the vehicle). The insurance pays him $7,000 for the loss.

Here is the calculation of the tax deduction for Frank's accident loss.

$12,000 (Frank's loss) - $7,000 (insurance payment) = $5,000

From $5,000 to $500 (on the injury limit) = $4,500 (casualty-loss deduction of Frank's)

When To Report

As a general rule, it is necessary to deduct a disaster loss in the tax return in the year in which the disaster occurred. But if the loss occurs in a declared federal disaster, it is possible to apply the tax deduction for the loss of victims to the tax return for the year preceding the disaster.

IRS publication 547 contains detailed information on the casualty loss.

Casualty Loss Gains

If you suffer a casualty loss and receive an insurance refund in excess of the appropriate amount of property damaged, destroyed or stolen, you can make a Casualty loss gains that you will have to report as income.

The adjusted property basis is usually the amount you paid to buy the property, plus everything you did to improve the property and increase its value, and less everything that happens to reduce its value.

It may not be necessary to report the gain as income if it is generated by the fact that the main house was destroyed. If you meet the requirements, you can exclude up to $250,000 ($500,000 if you are married and filing jointly) from your earnings.

There are detailed guidelines on how to report income from different types of Casualty Loss. Again, refer to IRS Publication 547 for more information.

Conclusion

Insurance for the coverage of valuable assets can be expensive, but even more so if a disaster occurs, especially since it cannot deduct Casualty loss occurring outside an area declared by the federal disaster.

If you ever undergo a loss due to a federal disaster, it is essential to understand how the tax deduction for casualty losses works and when you can. You must reduce the amount of the loss by any refund of the loss in addition to the $500 limit. But by suspending the AGI 10% requirement, you will be able to recover more uninsured and unpaid losses.

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