Casualty Losses: Claiming a Loss & Common Misconceptions
Casualty losses hit close to home for many of us in different locations of the US this year. Tornadoes, flooding, and wildfires left many homes destroyed and families misplaced. Casualty losses are losses that result in a partial or complete destruction of property caused by an identifiable event. Losses may be deductible if they are attributed to a federal disaster and if they do not exceed personal casualty gains.
Please be aware that to be able to claim a casualty loss on a tax return the cause of the loss must be deemed a Federally Declared Disaster Area by the President. For example, the tornado that hit Hamilton and Bradley counties earlier this year was a Federally Declared Disaster Area.
Determining the Amounts of Casualty Loss
The first thing a taxpayer needs to do is find the adjusted basis of the damaged property. This is normally the amount that you originally paid for the property plus any improvements on the property that were made before the casualty. Then you need to calculate the decrease of the property’s fair market value due to the disaster. The fair market value is the amount that you could sell your property to a willing buyer. Next, use the smaller of the adjusted basis or the decrease in fair market value of the property and deduct out the insurance and any other reimbursements you have received for the damage to the property. If the taxpayer expects to receive insurance proceeds, but may not receive reimbursement until the following year, the taxpayer must reduce the loss by this amount even if they have not received payment until a later tax year.
There are some limitations in the calculation above. Casualty losses for nonbusiness property are limited in two ways:
- The first $100 of casualty loss is nondeductible.
- Casualty losses can only be deducted up to 10% of adjusted gross income (AGI).
When and How to Claim a Casualty Loss
Taxpayers should use federal form 4684 to claim losses and include the applicable FEMA disaster declaration number assigned to the incident (found at fema.gov/disaster). The form should be filed with the taxpayer’s 1040, or with an amended return if electing to deduct in the preceding tax year.
Additional relief provided to taxpayers in federally declared disaster areas comes in the form of flexibility in the year in which the deduction is claimed. Taxpayers may elect to deduct losses in the year of the loss or in the tax year immediately preceding the tax year in which the disaster occurred.
Common Mistakes
1. Not keeping good records
- It is essential to keep records of every reimbursement and expense along the way for documentation purposes.
2. Deducting incidental living expenses that are due to the disaster
- Incidental living expenses incurred as a result of the disaster, such as temporary housing or meals, are not considered casualty loss expenses for tax purposes.
3. Purchasing upgraded property and deducting as a casualty loss
- Deductible repairs are only those that are necessary to restore the property to the previous condition and do not include repairs unrelated to the casualty. Therefore, property cannot be improved beyond the fair market value immediately preceding the casualty.
If you have questions or need additional information, please contact an HHM professional at 423.756.7771.