What is a Casualty Loss?
To qualify as a casualty, a loss must result from an identifiable event of a sudden, unexpected or unusual nature. Some examples would be a fire, automobile collision, storm, flood, hurricane, or other similar natural disaster. The loss need not be caused by natural forces; losses such as vandalism, theft, and human cause also may qualify as casualty losses. Minor accidents may be casualties, as magnitude has no relevance. Progressive deterioration is not regarded to be a casualty. The event must be identifiable, damaging to property, and sudden, unexpected or unusual in nature. Additionally, in computing casualty losses, the type of property involved must be ascertained, as the tax treatment for personal property is not the same as that for business-use property.
To claim a casualty loss deduction for non-business property, you must file Form 1040 and itemize your deductions on Schedule A. When the President of the United States declares that sections of the country are Federal Disaster Areas, casualty losses can be deducted either: (1) on the original return for the year of the loss, or (2) on an amended return filed for the tax year immediately preceding the year in which the disaster occurred (Section 165(i)(1), unless otherwise indicated, “section” refers to sections of the Internal Revenue Code or its associated regulations). Victims may reduce their remaining current-year estimated tax payments or withholding in anticipation of a current-year casualty loss deduction.
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).
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.
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.
- Casualty Loss Practice Guide : Guide to assist practitioners in dealing with certain tax problems that arise when a client is affected by a natural disaster; discusses rules for casualty losses and deductions for involuntary conversions, and provides information on relevant IRS publications
- Automatic Tax Relief for Natural Disaster Victims
- Disaster Financial Issues
- Estimated Casualty Losses of Real Property FAQs
IRS, State Agency, and Other Resources
- Disaster Relief Resource Center for Tax Professionals
- IRS Topic 515: Casualty, Disaster, and Theft Losses (including Federally Declared Disaster Areas)
- Disaster Assistance and Emergency Relief for Individuals and Businesses
- Revenue Procedure 2005-27: Details postponements of a variety of tax-related deadlines for taxpayers affected by a federally declared disaster, terrorist attack, or military action
- IRS Publication 547: Casualties, Disasters, and Thefts: Provides details on how to figure and claim a disaster loss
- IRS Publication 584: Casualties, Disasters, and Theft Loss Workbook (Personal-Use Property)
- IRS Publication 584B: Business Casualties, Disasters, and Theft Loss Workbook
- IRS Publication 1450: How to Request a Certificate of Release of Federal Tax Lien
- IRS Publication 2194: Disaster Resource Guide for Individuals and Businesses – Contains various IRS publications and forms related to claiming disaster losses
- IRS Publication 3833: Disaster Relief: Providing Assistance through Charitable Organizations – Explains how the public can use charitable organizations to help victims of disasters, and how new organizations may obtain tax-exempt status
- IRS Publication 4492: Information for Taxpayers Affected by Hurricanes Katrina, Rita and Wilma – Contains various IRS publications and forms related to claiming disaster relief under these particular hurricanes
- Form 4684 and Instructions: Casualties and Thefts – Form for reporting gains and losses from casualties and thefts
- Local Red Cross Chapters
- Federal Emergency Management Agency (FEMA): Shows a list of disaster areas by year and by state