A casualty loss can result from the damage, destruction or loss of your property from any sudden, unexpected and/or unusual event such as a flood, hurricane, tornado, fire or earthquake. However, the key words here are “sudden,” “unexpected” and “unusual.” Therefore, termite damage to your home is not considered a casualty loss, since it’s not sudden. But, damage to your car as a result of termite damage to your garage may be considered a casualty loss.
The IRS allows tax deductions for casualty losses sustained during the taxable year that are not compensated for by insurance or other means. These deductions are limited to the amount the casualty losses exceed the casualty gains, plus 10 percent of the adjusted gross income of the individual or business within the taxable year. Also, individual taxpayers are only allowed to include losses to the extent they exceed $100 for each casualty. The deduction is limited to those losses sustained during the taxable year and not compensated by insurance, or otherwise.
Understanding and filing casualty losses is no simple task. It can be an arduous and time-consuming process, and if it’s not done right, you and your business could face a multitude of headaches and lost money.
“It’s always best to consult your CPA on how to identify a casualty loss for tax purposes since each incident should be analyzed separately,” says Rene Lozano, CPA, a manager in the Tax Department at Briggs & Veselka, Co.
Smart Business spoke with Lozano about casualty losses, how to identify them and how to file taxes for them.
How have recent natural disasters affected casualty losses?
Hurricane Ike is a good example of a natural disaster that caused a lot of casualty losses. Besides ravaging Galveston with floodwaters, Ike sent strong winds and storms through Houston, destroying homes and businesses while leaving many without power for days and even weeks. Damage estimates from Ike are expected to exceed $27 billion, making it the third costliest U.S. hurricane of all time, behind Andrew in 1992 and Katrina in 2005.
The IRS often gives taxpayers located in presidentially declared disaster areas, such as Harris County, various concessions. The IRS gave individuals, partnerships and corporations time extensions to file their federal returns. They now have until Jan. 5, 2009, if they were located in a presidentially declared disaster area for Hurricane Ike. The IRS is also allowing taxpayers to take 2008 casualty losses for Hurricane Ike on their 2007 return. These are a few of the many concessions that the IRS has made.
How do you measure a casualty loss?
Individual taxpayers calculate their casualty losses on Form 4684, ‘Casualties and Thefts.’ A casualty loss calculation starts with the actual cost of the property and fair market value of the property before and after the casualty loss. The loss is the reduction of fair market value from the lesser of cost minus fair market value after the casualty, or the fair market value before the casualty less the fair market value after the casualty. The taxpayer will also have to subtract any insurance processes he or she received from the loss calculated. The loss is then reduced by $100 and then again by 10 percent of your adjusted gross income. The IRS has also waved the 10 percent of adjusted gross income reduction for Hurricane Ike victims.
How do you prove a casualty loss to the IRS?
This is a very good question, and there isn’t any one correct answer. The best answer is to document your loss as to the type of loss and when it happened and show how the loss was a result of a casualty. You also need to keep records that show you owned the property and that show the cost to repair or replace the property. The very best course of action is to contact your tax professional and determine where you have a deductible loss and what records should be kept and attained.
What problems or issues can arise when filing for casualty losses?
The most common problems the individual taxpayer encounters are insurance proceeds that are received after a loss has already been taken on his or her individual returns. If you received less than expected when you calculated your casualty loss, you can include the difference in the year you do not expect any more reimbursements. If you receive more than you expected, then you would include the difference as income in the year you received it. Please note that the taxpayer does not have to include the difference in income unless the taxpayer reduced his or her taxes in a previous year. So, if you did not have any taxable income to offset in a previous year in which the loss was taken, then you do not have to include additional insurance proceeds as income.
RENE LOZANO, CPA, is a manager in the Tax Department at Briggs & Veselka, Co. Reach him at firstname.lastname@example.org or (713) 667-9147.