Claiming Casualty Losses After Tax Reform

The southeast coast is no stranger to hurricanes, and this year was no different. Cat-5 Hurricane Dorian made landfall in the Bahamas and eventually made its way up the east coast of the US, even knocking on the door of our office in Myrtle Beach. We fared okay, but many of our neighbors did not; Dorian caused lots of wind and flood damage to the community. Undoubtedly, many of our neighbors will be seeking to claim a deduction for property losses when they file their taxes in 2020.

In years past, taxpayers who experienced an economic loss due to a natural disaster could claim a deduction on their federal income tax return. That has become trickier under tax reform.

Under the Tax Cuts and Jobs Act (TCJA), losses for individuals are now only deductible to the extent they are attributable to a federally declared disaster (federal casualty loss). Additionally, since you can no longer claim any miscellaneous itemized deductions, business casualty losses of property used in performing services as an employee cannot be deducted or used to offset gains.

A federal casualty loss involves casualty or theft loss of personal-use property that is attributable to a federally declared disaster. The casualty loss must occur in a state receiving a federal disaster declaration. If the loss isn’t attributable to a federally declared disaster, it is not considered a federal casualty loss, and you may not claim a casualty loss deduction unless an exception applies. 

The Federal Emergency Management Agency (FEMA) is responsible for such declarations. 

Note that there is an exception to the rule: If you have personal casualty gains reported on Form 4684, you may deduct personal casualty losses that aren’t attributable to a federally declared disaster to the extent they don’t exceed your personal casualty gains. 

Typically, a casualty loss is defined as the damage, destruction, or loss of your property from any sudden, unexpected, or unusual event. This includes natural disasters like hurricanes, floods, tornados, fires, earthquakes, and even volcanic eruptions. A casualty loss does not include normal wear and tear to your property or damage that happens over time, say from a termite infestation or intrusion of water from an aging, leaking roof. 

How to claim a casualty loss.

To claim a casualty loss on your federal income tax return, you must itemize your deductions using Schedule A, Itemized Deductions. You will have the option to report damage or loss to personal property (like your home or car) as well as damage or loss of business or income-producing property:

• If your property is personal-use property or is not entirely destroyed, the amount of your loss is the lesser of your adjusted basis or the decrease in the fair market value of your property because of the damage. In this case, your basis is typically what you paid for the item plus any long term improvements or renovations you made (like adding square footage).
• If your property is business or income-producing property, such as a rental property, and is completely destroyed, then the amount of your loss is your adjusted basis. For this purpose, your basis is typically what you paid for the item plus any long term improvements less any depreciation that you might have previously claimed for your business property.

The insurance question:

Hopefully, insurance will reimburse you for your loss, but experience tells us that that’s not always the case, especially when it comes to flood damage. Most homeowners and renters insurance doesn’t cover flood damage, so it’s an additional policy to purchase. People off of the coast often opt-out.

If you were reimbursed by insurance, or could otherwise salvage your property, you must report those adjustments. If you expect to be reimbursed by insurance but haven't yet received any money, you still have to report that. If you receive more or less from insurance than expected, you can amend your return or report the adjustment on next year's return.

For damage not covered or reimbursed by any insurance, subtract $100 for each event (meaning each storm or disaster), and then subtract 10% of your adjusted gross income (AGI) from that amount to calculate your allowable loss.

Here's an example (again, this assumes you suffered damage located in a federally declared disaster area):

Hurricane Dorian decreased the value of your home by $20,000. Your AGI is $75,000. You received $5,000 in insurance money. Your initial loss is $20,000 less $5,000 (insurance), or $15,000. That amount is reduced to $14,900 ($15,000 less $100 for the single hurricane). Finally, subtract 10% of your AGI -- $7,500. Your casualty loss, for tax purposes, is $7,400.

Note: If after calculating your loss deduction you find it's more than your income, you may have a net operating loss. You do not have to own a business to claim a casualty loss. 

Final thoughts

Document, document, document. As with all deductions, keeping excellent records is essential. Before and after photos of the damage can be a tremendous asset, and hopefully, you have them. Really, we should all have photos of our high-value property taken while things are good so we have something to show if they are ever damaged. Updated appraisals (before disaster strikes) are also recommended.

Of course, keep receipts of repairs and replacement values. 

Casualty losses are generally deductible in the year the loss occurred. However, if you have a casualty loss from a federally declared disaster, you can choose to treat it as having occurred in the previous year.

Tax relief other than casualty loss deductions may also be available, including extensions of time to file and make payments. 

As much as we hope disaster will never strike, we know that it will. Our best bet is to be prepared and to be smart. For more information on claiming your deduction for casualty loss this year, don’t hesitate to reach out.