With the recent flooding here in Denham Springs, Baton Rouge, and the surrounding areas, now’s as good as time as any to go over the basics of the casualty loss deduction.
What is a casualty loss?
A casualty loss is the decrease in fair market value of personal or business/investment property as a result of any sudden, unexpected, or unusual event that causes damage or destruction to property. Events such as a flood, hurricane, tornado, fire, or earthquake would qualify. These events are sudden and generally unexpected.
What’s special about a casualty loss?
First, we’re generally not allowed to deduct any decreases in value of business/investment property that we haven’t sold. We have to wait until we sell the property at a loss or abandon it to claim a deduction.
Second, we’re generally not allowed to deduct any losses from personal-use property.
Well, when the loss is a result of a casualty, we’re allowed to deduct as a casualty loss the decreases in value of both business/investment property and personal-use property.
Well how much is deductible as a result of a casualty?
The casualty loss will be the lesser of–
- The decrease in the Fair Market Value of the property as a result of the casualty
- The adjusted basis of the property
So if you lose your Pikachu Illustrator Card valued at $100,000 that you bought for $12 dollars, your deduction would be limited to $12. Even though you lost $100,000, your adjusted basis in the card was only $12.
How are we supposed to measure the fair market value of our property!?!11
Much of the property lost in the recent flooding did not have a readily available value like the Pikachu Illustrator Card. How are we required to measure the value of the loss? Well, tax regulations provide two methods:
- The fair market value immediately before and after the casualty shall generally be ascertained by a competent appraiser.
- The cost of repairs to the property is acceptable as evidence of the loss of value if the taxpayer can show;
- the repairs are necessary to restore the property to its condition before the casualty
- the amount spent is not excessive
- repairs aren’t made to damage not caused by the casualty
- the value of the property after the repairs doesn’t exceed the value of the property before the casualty
So our casualty loss is the decrease in the fair market value of our property as a result of the casualty. We can measure the decrease in value by using 1) a competent appraiser, or 2) the cost of repairs.
Real Property – homes, buildings
Using a Competent Appraiser (Method 1)
If you had insurance, the insurance adjuster would usually be the competent appraiser. His report will show the actual cash value (replacement cost minus depreciation for personal use) of the property damaged. You would generally use this actual cash value as the decrease in fair market value and thus the amount of your casualty loss.
Using Cost of Repairs (Method 2)
If you didn’t have insurance, you may or may not want to use the cost of repairs to the property to value the loss. You may end up doing a substantial amount of the work to repair the property yourself. Your time away from work won’t count as a cost when determining the repair cost. Also, it may cost less to repair the property than the actual decrease in value to your property as a result of the casualty.
It’s usually a good idea to hire an adjuster or appraiser to give you a value before and after the casualty.
Personal property – contents of homes, buildings
The IRS understands that you can’t just get an appraisal of items you’ve lost in a casualty. Further, you might end up losing more than the coverage for contents loss for a homeowner’s policy. So, now’s a good time to look a bit closer on how we measure the amount of the casualty loss.
The regulations actually say the fair market value “shall generally be ascertained by a competent appraiser.” It doesn’t say you have to hire an independent appraiser. You can be the appraiser!
No matter if you hire an independent appraiser or you determine the value of the property loss, the IRS will evaluate whether the appraiser was “competent” by considering, among other things:
- the appraiser’s familiarity with your property before and after the casualty or theft.
- the appraiser’s knowledge of sales of comparable property in the area.
- the appraiser’s knowledge of conditions in the area of the casualty.
- the appraiser’s method of appraisal.
The more organized and methodical the valuation of the contents loss, the more likely it is the IRS would accept the valuation. You should prepare a schedule itemizing each piece of property you’ve lost, the date you purchased it (guestimate it), the amount paid, the replacement cost, and a depreciation allowance for personal use.
If the amount of your loss is substantial, you might consider hiring an independent appraiser to value the contents.
What if I receive payments from insurance company?
Your casualty loss is reduced by the amount of insurance proceeds you receive or expect to receive.
So I figured my casualty loss, how much can I actually deduct?
First, the casualty loss will be reduced by $100.
Second, the casualty loss will be reduced by 10% of your adjusted gross income.
Third, the casualty loss is an itemized deduction. You have to itemize in order to take the deduction.
When can I claim the casualty loss?
You can claim the casualty loss on the return for the year the casualty occurred. However, if the casualty occurred as a result of a federally declared disaster area, you can claim the loss on the prior year’s return if you haven’t filed the return yet or by filing an amended return if you have.
You should evaluate which year will produce the greater tax savings.
What if I have a gain from a casualty?
You may have a gain if you receive insurance proceeds for damage to business property that you have fully depreciated. You may be able to defer part or all of the gain.
There’s a bit of thought and planning that goes into dealing with the result of casualties for tax purposes. Before you take any action (I may be a bit late here), you should review the tax consequences so you end up with the greatest tax benefit..