Tax breaks for property losses
Real Estate Tax Talk
We’ve all seen on the news that large portions of the country have been devastated by tornados and floods. Unfortunately, homeowners are not always fully insured — or insured at all — against losses due to such events. Fortunately, the Internal Revenue Service can help because uninsured casualty losses are tax deductible.
What is a casualty?
A “casualty” is damage, destruction, or loss of property due to an event that is sudden, unexpected, or unusual. Deductible casualty losses can result from many different causes, including, but not limited to:
- Government-ordered demolition or relocation of a building that is unsafe to use because of a disaster,
- Sonic booms,
- Storms, including hurricanes and tornadoes,
- Terrorist attacks,
- Vandalism, including vandalism to rental property by tenants, and
- Volcanic eruptions.
One thing all the events in the list above have in common is that they are sudden — they happen quickly. Suddenness is the hallmark of a casualty loss. Thus, loss of property due to slow, progressive deterioration is not deductible as a casualty loss.
For example, the steady weakening or deterioration of a building due to normal wind and weather conditions is not a deductible casualty loss.
When casualty losses are deductible
In the case of a home used solely for personal purposes, a casualty loss may be deducted only if:
- You itemize deductions,
- Each casualty loss exceeds $100, and
- The total of all casualties suffered during the year exceeds 10 percent of your adjusted gross income after subtracting $100 from each loss suffered.
Losses to business property are not subject to the above limitations.
Amount of casualty loss deduction
How much you may deduct depends on whether the property involved is completely destroyed or partially destroyed, and whether the loss was covered by insurance. If more than one item is damaged or destroyed, you must figure your deduction separately for each.
If your property is personal-use property or is not completely destroyed, the amount of your casualty or theft loss is the lesser of:
- Your property’s adjusted basis (usually its cost, increased or decreased by improvements and/or depreciation), or
- The decrease in fair market value of your property due to the casualty.
If your property is business or income-producing property, such as rental property, and is completely destroyed, and the fair market value of the property before the casualty is less than the adjusted basis of the property, then the amount of your loss is your adjusted basis.
The role of insurance
You may take a deduction for casualty losses to your property only if — and only to the extent that — the loss is not covered by insurance. If the loss is fully covered, you get no deduction. You can’t avoid this rule by not filing an insurance claim.
If you have insurance coverage, you must timely file a claim, even if it will result in cancellation of your policy or an increase in your premiums. If you don’t file an insurance claim, you cannot obtain a casualty loss deduction.
You must reduce the amount of your claimed casualty loss by any insurance recovery you receive or reasonably expect to receive, even if it hasn’t yet been paid. If it later turns out that you receive less insurance than you expected, you can deduct the amount the following year.
If you receive more than you expected and claimed as a casualty loss, the extra amount is included as income for the year it is received.
Casualty losses are generally deductible in the year the casualty occurs. However, if you suffer a deductible casualty loss in an area that is declared a federal disaster by the president, you may elect to deduct the loss for your taxes for the previous year.
This will provide you with a quick tax refund since you’ll get back part of the tax you paid for the prior year. If you have already filed your return for the prior year, you can claim a disaster loss against that year’s income by filing an amended return.
You can determine if an area has been declared a disaster area by checking the Federal Emergency Management Administration (FEMA) website at http://www.fema.gov/news/disasters.fema.
A great deal more useful information about deducting casualty losses may be found at the IRS website at www.irs.gov.