Casualty Loss and Disaster Relief

How to Determine the Amount of Loss

To deduct a casualty loss, the taxpayer must first calculate the loss and then determine any limits on the amount of loss that may be deducted. A casualty loss is calculated by subtracting any insurance or other reimbursement received or expected from the smaller of the decrease in fair market value (FMV) of the property as a result of the casualty or the adjusted basis in the property before the event (Treas. Regs § 1.165-7(b)(1)).

Decrease in Fair Market Value
The decrease in FMV is the difference between the property’s value immediately before and immediately after the casualty (Treas. Regs. §1.165-7(b)(1)(i)). The term “immediately after” the casualty is important, because two or three years may pass before an IRS audit. Even if there are no interim improvements, general appreciation in value may mask some of the loss incurred.

To calculate the decrease in FMV caused by a casualty, make a determination of the actual price which the property could have sold for immediately before and immediately after the loss. The worksheets in IRS Publication 584, Casualty, Disaster, and Theft Loss Workbook, and IRS Publication 584B, Business Casualty, Disaster, and Theft Loss Workbook, provide assistance with the loss calculation.

An independent appraisal by a qualified appraiser is mandatory in most situations (Treas. Regs. §1.165-7(a)(2)(i)). Minimum guidelines for appraisal formats have been issued by the IRS in Rev. Proc. 66-49, 1966-2 C.B. 1257, and in IRS Publication 561, Determining the Value of Donated Property. The appraiser should be a recognized expert in the field relating to the property being valued. Even though appraisal fees can be expensive, the absence of qualified appraisals can subject the taxpayer to undervaluation penalties and a myriad of other problems.

Guidance for use in estimating real property casualty losses is available as part of the AICPA’s Statements on Standards for Tax Services (SSTS).

Adjusted Basis
Basis for casualty loss purposes is the same as the basis that would be used for calculating gain or loss on sale of the property. During the period the property is owned, various events may take place that change the basis. Some events, such as additions or permanent improvements to the property, increase basis. IRS Publication 551, Basis of Assets, provides more information on calculating the basis of a property.

Insurance and Other Reimbursements
No casualty loss deduction is allowed to the extent the loss is reimbursable. If the reimbursement exceeds the tentative loss, the taxpayer may have taxable income. If the property is covered by insurance, a timely insurance claim for reimbursement of a loss should be filed. Otherwise, no deduction as a casualty loss is allowed. Insurance, grants, gifts, and other payments received to help after the disaster are considered reimbursements only if they are specifically designated to repair or replace the property. If the money is designated for other purposes, or if there are no conditions on its use, the money is not a reimbursement even if used to restore the property.

Disaster Loss

A disaster loss is a loss that is attributable to a casualty occurring in an area that the President declares a disaster area entitled to federal assistance. For example, in 2014 several states were declared eligible for assistance from the federal government under the Disaster Relief and Emergency Assistance Act (FEMA) (FEMA-1731-DR). FEMA maintains an updated listing of the disaster declarations by year on their website.

One of the first major hurdles in assisting victims of disasters is in determining and documenting what assets were lost or damaged, the original cost and tax basis (if applicable) of those items, and their FMV. The IRS has a Record Reconstruction page to assist taxpayers with reconstructing their records after a casualty loss is incurred. Tax professionals should consult the IRS website for the most current information on filing deadlines in disaster areas.

AICPA Resources

IRS, State Agency, and Other Resources