Casualty Loss Deduction for Natural Disasters

If you’ve turned on the news lately, you’ve undoubtedly noticed that myriad natural disasters unfolding across the nation. Tropical storms, hurricanes, and wildfires, you name it. Given the situation, we felt it was high time to provide a refresher on casualty loss deductions. If you’re not familiar with the term, it is accountant-speak for property damage. If you prefer to consume this information via video, watch this. Here is what is important to know about this deduction:

Individuals:

• In order to be eligible for the casualty loss deduction, the property damage has to occur in a Federally declared disaster zone. And, the damage needs to be a result of the disaster itself. A list of these disasters can be found here.
• Your tax loss before adjustment (discussed below) is, generally speaking, the reduction in fair market value of the asset LESS any insurance proceeds. So, if you sustained $500K in damage, and an insurance reimbursement of $300K, then you’d have a $200K loss before adjustments.
• Unfortunately, you’ll need to adjust your loss for 2 items. First, the loss is only deductible to the extent it exceeds 10% of your AGI. Second, you must reduce the loss by $100 per event. Why the IRS cares about this $100 adjustment is beyond me. So if, in the above example, your AGI was $100K, then your actual deduction will be $189,900 ($200K – ($100K x 10%) - $100).
• You also must itemize to take advantage of the deduction so the benefit could be marginalized even more to the extent of the Standard Deduction you would have taken otherwise.
• Whatever your loss ends up being, you are able to claim it as a deduction on a previous year tax return. Thus, if the loss happened in 2020, you could claim the loss on your 2019 tax return. If you already filed the return, you’d need to amend it to claim the loss. This allows you to obtain an immediate benefit in the form of a tax refund.

Businesses:

• You DO NOT have to adjust your casualty loss deduction by 10% of AGI nor $100 per event.
• Business losses may be reduced much more than a personal loss since the loss is limited to the property’s adjusted tax basis immediately before the loss. Because businesses take depreciation, often in the form of bonus depreciation, it’s likely that the FMV exceeds the tax basis in a lot of cases. In such cases, you could actually have gain.
• If you have a gain from the insurance proceeds exceeding your tax basis, you can defer the gain by investing the proceeds back into similar replacement property.
• Thanks to the CARES Act, business can use losses (which could be a result of the casualty loss) to offset income for the 5 previous tax years. The NOL carryback would reduce taxable income which would result in a refund for those tax years. You’d need to amend both the business return and individual returns to take advantage of this.

There is a lot more nuance to the above, more than you’d care to know here. But, that’s why you hire a firm like ours to help you navigate it.

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