Frequently Asked Tax Questions -- January 26, 1997

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, January 26, 1997.

 

How to Identify and Claim Casualty Losses

ROBERT L. SOMMERS

Note: This exercise is for educational purposes only and is not intended to be legal or tax advice. Your particular facts and circumstances must be considered when applying the U.S. tax law. You should always consult with a competent tax professional with respect to your particular situation.

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How to Identify and Claim Casualty Losses

Floods, fires, earthquakes, mud slides. Californians have suffered their share of such disasters. The tax law provides relief, but the rules are complex. A deduction for a casualty loss involves the following issues: (1) Was the property insured; (2) Was the loss suffered by a sudden event (a "casualty"); (3) Was the property personal or used in a trade or business; (4) Did the president declare a national disaster; and (5) Is the property your principal residence?


Measuring Your Loss:

A casualty loss is the difference between the property's fair market value immediately before and after the casualty, as determined by a professional appraisal. However, the loss amount is limited to the property's basis (generally the cost of the property, plus improvements). Example: A home valued at $225,000 is flooded and immediately thereafter is worth only $100,000. If the home's basis was $150,000, $125,000 would be the total casualty loss -- well under the ceiling of the home's original basis of $150,000. If the home's basis was $75,000, then the loss would be capped at $75,000. In addition, each casualty loss is subject to a $100 deduction, therefore, the amount remaining after applying the $100 deductible is your casualty loss. The loss is claimed as an itemized deduction on Schedule A of your Form 1040. Form 4684 is used to report casualty gains and losses of nonbusiness property.


Insurance:

The tax loss deduction must be reduced by any insurance or reimbursement received. A loss cannot be deducted if it was covered by insurance, but you fail to file a timely claim for the loss. If the amount of insurance or reimbursement received exceeds you basis in the property, you would have a casualty gain. Casualty gains and losses are netted against each other.


Definition of Casualty:

A casualty is usually a single sudden, unexpected or usual event, such as fire, earthquake, flood, hurricane, explosion, vandalism, sonic boom, waves and winds. Unintentional damage to an automobile can be a casualty. Gradual decay or destruction (termite, dry rot or pollution damage) are not considered casualties by the IRS.

Personal or business property:

Losses to personal property (except a principal residence, described below) are limited to casualty gains, plus the excess over 10% of the taxpayer's adjusted gross income (AGI). For example, if the taxpayer has $50,000 in AGI, a casualty gain of $10,000 and a casualty loss of $30,000 (after the $100 deductible), then $15,000 would be deductible (10% of AGI is $5,000; $30,000 loss - $10,000 gain = $20,000 net loss; $20,000 less $5,000 = $15,000 deductible).

Trusts and estates may claim a casualty loss as if they were individuals, except that their administrative expenses are deducted as part of AGI. Business losses are usually fully deductible without any AGI limitations.


Presidentially Declared Disasters:

When you lose property in a presidentially declared disaster ("disaster loss"), other rules apply. You may elect to deduct the loss in the current or preceding year. This decision must be made by the filing date of the return for the year in which the disaster occurred. The election may also be made by amending last year's tax return to declare the loss, which could provide you with an immediate tax refund. AGI limitations for the preceding year apply with this option.

For business owners, new legislation permits you to replace any "tangible" property (generally, property other than real estate) used in your business with any other tangible business property without any imposition of taxation. This will permit business owners suffering a casualty loss to use the insurance or other proceeds for a new venture. Example: the owner of a restaurant who suffers a disaster loss may use the insurance proceeds to buy computer equipment for a new consulting venture. This rule will apply to disasters after December 31, 1994.


Presidentially Declared Disaster: Loss of Your Home:

If you suffer damage to your principal residence or its contents from a disaster loss, you may replace your home and contents (provided those contents were not separately scheduled for insurance purposes) within four years after the end of the first taxable year in which you receive the insurance proceeds. For example, if you lose your home in October 1992, but do not receive the insurance proceeds until May 1993, you have until December 31, 1997, to replace your home and contents tax-free (four years after the close of the first year you receive the proceeds). These rules also apply to renters who have insured their household contents.

Loss of your home and its contents is considered a single item of property so that insurance proceeds can be considered a single pool of funds with which to replace your home and contents. You will recognize a gain only if the pool of funds exceeds the cost of replacing your home and contents.




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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**