The effects of a natural disaster can be devastating to local individuals, families, and businesses. Not only do victims deal with the personal and communal heartaches that accompany such disasters, but the situation is also made worse when layered with economic distress due to the loss of hard-earned assets. Below is an outline of federal tax benefits associated with casualty losses to help those unsure of the aid available to them.
What Is It
A casualty is defined as a “damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.”1 Such events often include floods, fires, hurricanes, tornadoes, or other similar events. Depending on whether the losses are to your business or yourself, or linked to a federally declared disaster, the tax code may allow for the deduction of losses related to these unfortunate events.
Deductible Losses: What To Expect
Deductible casualty losses are described as the difference between the fair market value (FMV) of the property immediately before and after the casualty event but cannot exceed the adjusted tax basis of the property. In certain instances when business or income-producing property is completely destroyed, the casualty loss is calculated as the adjusted basis in the property, less any salvage value.
The loss is further reduced by any reimbursement from insurance or any other source. When figuring the decrease in FMV, taxpayers should not include related expenses such as temporary housing or rental cars; however, such costs could be deductible if related to damaged business property.
Alternatively, a taxpayer may evidence a loss by the cost of repairs to the damaged property as long as the repairs are necessary to restore the property to its condition before being damaged, not excessive, do not repair more than the damage incurred, and do not increase the property’s value above its value before the casualty occurred.2
Action Item—Appraisal or Safe Harbor
To determine a decrease in FMV, an appraiser with familiarity and knowledge of the property, sales of comparable property, and the casualty area should be engaged. There are other “safe harbor” methods that the IRS will not challenge for personal casualty losses related to a personal residence and belongings. Forvis Mazars professionals can help you understand what these methods are and how to apply them.
Businesses that incur inventory losses may deduct those losses either through cost of goods sold by excluding the damaged items from ending inventory or deducting the loss separately. If the latter option is chosen, businesses should remove the inventory items from cost of goods sold to not double count the loss. In either case, adjustments for insurance should be made to properly reduce the loss.
Personal (as opposed to business) casualty loss deductions are further subject to certain requirements and limitations. First, a taxpayer must itemize their deductions. Second, deductible losses are reduced by $100 per casualty. Third, only losses that exceed 10% of the taxpayer’s adjusted gross income (AGI) are deductible.
For example, a taxpayer’s car with a laptop inside was damaged by a flood. The car’s FMV was $20,000 and the laptop’s FMV was $1,000 immediately before the casualty event. The car was valued at $500, and the laptop was deemed worthless after the flood. The taxpayer’s AGI is $100,000 and insurance reimbursed the taxpayer $5,000 for the car and laptop.
First, the taxpayer’s total loss is calculated as $21,000 (FMV before casualty) - $500 (FMV after casualty) - $5,000 (insurance) = $15,500. Next, the loss is reduced by $100 or $15,500 - $100 = $15,400. Finally, the amount that is 10% of the taxpayer’s AGI, or $100,000 x 10% = $10,000, would not be deductible. This example would result in a $15,500 - $10,000 = $5,500 casualty loss deduction for the taxpayer.
Action Item: Documentation
The IRS provides Publications 584 (for personal casualty losses) and 584-B (for business casualty losses) with workbooks designed to help taxpayers maintain records of their lost property and to calculate their casualty losses. When the disaster is still fresh, keeping simple, contemporaneous records is one of the most helpful things you can do to later determine your potential tax benefits with a Forvis Mazars professional.
A casualty loss is typically deducted in the year the federally declared disaster occurs. An election may be made to deduct the loss in the immediate year proceeding the disaster year if the disaster happened in an area where public or individual assistance was provided, as designated on the Federal Emergency Management Agency (FEMA) website. An amended return would be required to deduct the loss in the preceding year, and it must be filed on or before six months after the taxpayer’s due date for filing their original return (without extensions).
According to the current rules enacted under the Tax Cuts and Jobs Act (TCJA), for taxable years 2018 through 2025, personal casualty losses are only deductible to the extent of personal casualty gains, or for losses resulting from federally declared disasters. Federally declared disasters can be found on the FEMA website. IRS announcements for tax relief, that generally follow FEMA disaster declarations, can be found on its respective website.
It is also worthwhile for businesses to learn more about Section 139 disaster relief payments for employees. Our Section 139 Payments FORsight™ details how the payments are excluded from the employee’s taxable income and payroll taxes, while also tax-deductible by the employer.
There are other nuances associated with casualty loss deductions that our Forvis Mazars professionals can help you navigate. We stand ready to assist those affected by these unfortunate events and help where we can. Please contact us for assistance or for more information.