For the years 2018 – 2025, personal casualty losses are not deductible on one’s tax return unless the losses are attributable to a federally declared disaster. This column discusses what a federal declared disaster is, how a casualty loss is computed, and how a casualty loss is deducted on one’s federal income tax return.
The Tax Cuts and Jobs Act of 2017 (TCJA) suspends the deduction for personal casualty and theft losses except for losses incurred in a federally declared disaster for tax years beginning after Dec. 31, 2017 and ending Dec. 31, 2025.
A federally declared disaster is a disaster that occurred in an area directed by the President of the United States to be eligible for federal assistance (Internal Revenue Code Section 165(h)(5)(A)). An ongoing list of federally declared disasters is available on the Federal Emergency Management Agency (FEMA) Web site at www.fema.gov/disasters.
The following is a list of some of the Presidential-declared federal disaster areas that occurred during 2019:
- Parts of Georgia and South Carolina affected by Hurricane Dorian that occurred August 29 through Sept. 7, 2019;
- parts of Louisiana affected by Hurricane Barry from July 10 through July 15,2019;
- New Hampshire due to severe storms and flooding that occurred July 11 and 12, 2019:
- Montana’s North Hills Fire that occurred July 26 through August 1, 2019; and
- Oklahoma that was affected by severe storms, tornadoes and flooding from April 30 through May 1, 2019.
How is the Casualty Loss and Deduction Computed?
First, a definition of a casualty loss for federal tax purposes. A casualty loss is the result of sudden, unexpected or unusual events resulting in physical damage of a property. To claim a loss, an individual must have a property interest or ownership. The damage must be permanent and not a temporary decline in value.
Specifically, a casualty loss equals:
(1) The lesser of:
(a) adjusted basis in the property before the casualty, or
(b) decrease in the fair market value of the property as a result of the casualty, minus
(2) Minus any insurance or other reimbursement received or is expected to be received.
There are limitations imposed on casualty loss deductions; namely: (1) $100 per casualty. Reduction applies to each event that causes the casualty. For example, a federally declared disaster damages the house, garage and the car. There is only $100 reduction and not three $100 reductions; and (2) 10 percent of adjusted gross income (AGI). Reduce the total of all casualty or theft losses on personal-use property by 10 percent of one’s adjusted gross income (AGI) in the year of the casualty. Apply this reduction after the $100 per casualty reduction.
How is a Potential Casualty Loss Deduction Affected by Insurance Reimbursement?
The casualty loss amount must be reduced by the actual insurance reimbursement or if that is not known, by any expected reimbursement. If the property is covered by insurance, an insurance claim must be filed. Otherwise, the casualty loss is not allowed. If the insurance reimbursement exceeds the casualty amount, (that is, the recovery amount is more than the adjusted basis in the damaged or destroyed property), the resulting net profit is taxable in the year of insurance reimbursement.
If a casualty loss is deducted in one year based on an expected insurance reimbursement, and the actual reimbursement in a following year turns out to be more or less than expected, an adjustment is usually required. The next section explains in more detail the timing of the casualty loss deduction with respect to insurance reimbursement.
Timing of the Casualty Loss Deduction
In general, a casualty loss under Internal Revenue Code Section 165(a) is deductible only in the year the loss is sustained. However, with respect to federally declared losses, a casualty loss may be claimed in the tax year preceding the disaster. A discussion of which year to claim the loss is presented below.
If a casualty loss occurs and there is a claim for reimbursement with a reasonable prospect of recovery via insurance or other means, no portion of the loss up to the expected reimbursement is deductible until there is reasonable certainty whether the reimbursement will be received. With respect to insurance reimbursement, note the following:
- Any portion of the casualty loss not covered by insurance is allowed during the taxable year when the casualty loss occurred.
- When an individual deducts a casualty loss in one calendar year and in a subsequent calendar year receives a reimbursement, the reimbursement is considered taxable income in the calendar year in which the insurance reimbursement is received.
- If the eventual reimbursement turns out to be less than originally expected, a casualty loss may be claimed in the year it is determined the individual cannot reasonably expect any further reimbursement.
- The original tax returns (in which the casualty loss was deducted) should not be amended if a reimbursement in a subsequent taxable year turns out to be less than expected. Any resulting additional casualty loss is treated as if sustained in the year of insurance settlement.
The following examples help illustrate:
Example 1. Jerry’s home is destroyed in a 2019 federally declared disaster. Jerry originally bought the house for $800,000 and the loss was $750,000. Jerry filed an insurance claim and expects to receive full reimbursement from his insurance company for the entire loss. He therefore does not have a casualty loss for the year 2019.
But the claim is rejected by the insurance company. He filed a lawsuit in early 2020, and he and the insurance company agreed on a settlement of $650,000. The $100,000 casualty loss ($750,000 loss minus the $650,000 reimbursement) will be claimed on Jerry’s 2020 federal tax return (the year of settlement) subject to the $100 and 10 percent-of-AGI limitations. Also, since the fire started as a result of a federally declared disaster and his home is located in the disaster area, Jerry has the option of claiming the casualty loss on his 2019 tax return and deducting the $100,000 loss on his 2019 tax return (subject to the $100 and 10 percent of AGI limitation).
Example 2. Nancy paid $450,000 for her home ($425,000 for the house and $25,000 for the land). A federally declared disaster during 2019 destroyed her home during a hurricane. An appraisal valued the property as a whole for $500,000 before the hurricane, but only $25,000 after the hurricane. The starting point for determining Nancy’s casualty loss is $500,000 less $25,000, or $475,000. If Nancy’s insurance company reimbursed her $460,000 for the house, then Nancy will have a casualty loss of $475,000 (cost basis for casualty loss) less $460,000 (insurance company reimbursement), or $15,000. Nancy has the option of claiming the $15,000 casualty loss on her 2019 return or amending her 2018 federal tax return and claiming the $15,000 loss.
Claiming Casualty Losses on An Individual’s Federal Tax Return
Personal casualty or theft losses that are attributed to federally declared disaster areas are computed on IRS Form 4684, Section A and then reported on Form 1040, Schedule A, line 15. An individual must itemize on his or her federal income tax return in order to deduct a casualty or theft loss.
Under the TCJA, an individual who incurs a personal casualty loss that is not attributed to a federally declared disaster area deemed by the President of the United States cannot claim the loss. However, a special rule allows a deduction for a personal casualty loss not attributable to a federally declared disaster to the extent the loss does not exceed any personal casualty gains. A personal casualty gain is the recognized gain from any involuntary conversion of non-business, not-for-profit property arising from a casualty or theft, in which an individual receives an insurance payment or other reimbursement exceeding his or her adjusted basis in the property.
An individual may elect to take a federally declared disaster loss on the income tax return for the immediately preceding year (IRC Section 165(i)(1) election). If this election is made, the disaster resulting in the loss is treated as having occurred during the taxable year in which the deduction is claimed.
An individual must make the IRC Sec. 165(i)(1) election on an original federal tax return or an amended federal tax return for the preceding year. The original federal tax return or amended federal tax return must be filed on or before the date that is six months after the original due date for the individual’s federal tax return for the disaster year. This is determined without regard to any extension of time. In Example 1 above, since Jerry’s home was destroyed in a federally declared disaster that occurred in 2019, Jerry has until Oct. 15, 2020 to make the IRC Sec. 165(i)(1) election.
An election should contain the name or a description of the disaster, the date(s) the disaster took place and the city, town, county, parish, state and zip code where the damaged or destroyed property was located.
Some things to consider when choosing which year to take a disaster casualty loss: (1) the individual’s need for cash (amending a prior year tax return may result in a quicker refund); (2) the individual’s tax bracket and taxable income for each year (higher tax bracket may result in larger casualty loss deduction); and (3) the individual’s adjusted gross income (AGI) during the year of the disaster and the preceding year (lower AGI results in larger casualty deduction. This is because of the 10 percent of AGI limitation for the casualty loss).